A decline in the general level of prices for goods and services in an economy.
In macroeconomic terms, deflation usually accompanies a contraction in monetary supply. However, prices can decline for a wide range of reasons — including low levels of productivity in the economy, advances in technology, or simply lower levels of demand.
In the context of Bitcoin, deflation tends to refer to the cryptocurrency’s maximum supply. There will only ever be 21 million Bitcoins mined — and at this point, no new coins will be created, and no more block rewards will be given.
In fact, the circulating supply of BTC will reduce over time as private keys are lost and coins become unrecoverable. Many other cryptocurrencies are also deflationary in nature.
Deflationary currency systems are very unusual in economic history — in fact, cryptocurrencies probably represent the first example of such an approach. Economists are interested in deflationary systems for exactly this reason, and some believe that crypto’s deflationary nature will completely revolutionize our approach to money. Others, however, are skeptical, believing that a deflationary currency system will inevitably result in hoarding and liquidity problems.
The Bitcoin community has always been preoccupied with the impact of a deflationary system. For those who wish for the currency to become a widespread means of exchange (as opposed to pure speculation), concerns about deflation are tied up with conversations on subdivisions of Bitcoin (such as into bits.) Proponents believe that Bitcoin’s theoretical infinite divisibility will help to solve potential problems associated with deflation.
Furthermore, some believe that the problem is in fact not with the deflationary nature of crypto, but with the inflationary nature of fiat currencies. These people tend to suggest that prices will naturally fall in the Bitcoin economy through increases in innovation and productivity, but that a deflationary spiral would not occur because Bitcoin is not based on theoretical loans but on a real and finite monetary supply.