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Ethereum: How does bitcoin manage the money supply?

Published by Terlumun Aondover on February 13th, 2025.

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Bitcoin Money Supply Limits: Understanding the Economics of Ethereum and Cryptocurrencies

As the world continues to face the challenge of managing a growing economy, cryptocurrencies like Bitcoin and Ethereum have emerged as an alternative. One of the biggest concerns surrounding these digital assets is how to deal with the limited money supply. In this article, we examine how Bitcoin was designed to prevent excessive money creation and address some of the most common criticisms regarding its lack of adoption.

Definition of Money and Its Limits

Before we get into the specifics of Bitcoin’s monetary policy, it is important to understand what is meant by “money” and its limitations. The most widely used definitions of money include:

M2: This narrow measure of money supply focuses on the total amount of cash in circulation (M1), bank deposits (M2), and other liquid assets.

M3: This broader definition includes not only cash in circulation, but also checking accounts, savings accounts, and other liquid assets.

Unlike traditional fiat currencies, cryptocurrencies like Bitcoin follow a fundamentally different monetary policy. Unlike fiat currencies, which are issued by governments and subject to their discretion, cryptocurrencies are decentralized and governed by a community-driven consensus algorithm.

Ethereum Solution

Ethereum, the second-largest cryptocurrency by market cap, was designed to overcome some of the limitations associated with traditional fiat currencies. Here are some key features that illustrate how Ethereum addresses money supply constraints:

Decentralized Ledger Technology

: The Ethereum blockchain is an open-source, decentralized ledger that records all transactions on the network. This ensures that every participant in the system has an equal and verifiable record of all transactions.

Smart Contracts: Smart contracts are contracts that are automatically executed, with the terms of the contract written directly into lines of code. They enable automation and ensure that transactions are executed fairly and transparently.

Gas Mechanism: The Ethereum gas mechanism is designed to prevent excessive money creation by mandating a limited supply of gas, which is essentially a measure of the computing power required to execute smart contracts.

Limiting the Money Supply: How Bitcoin Meets the Ethereum Solution

Although both Bitcoin and Ethereum aim to solve the problem of limited money supply through decentralized ledger technology and smart contract-based mechanisms, there are key differences between their approaches:

Fiat Currency vs. Decentralized Tokens: Fiat currencies can be created relatively easily by governments or central banks, while decentralized tokens like Bitcoin require a decentralized consensus mechanism.

Transaction Volume vs. Transaction Value: While the transaction volume of both fiat currencies and digital assets is low compared to their real-world counterparts, the transaction value is much higher in the case of fiat currencies.

To solve this problem, Ethereum has implemented several mechanisms to limit the money supply:

Gas Mechanism: As mentioned earlier, the gas mechanism ensures that each execution of a smart contract requires a certain amount of computing power (gas) before it can proceed.

Block Size Limit: The block size limit, which determines the maximum number of transactions that can be included in each block, helps prevent excessive money creation by limiting the total volume of transactions.

Conclusion

In summary, while Bitcoin and Ethereum have different approaches to managing their money supply, the goal of both systems is to prevent excessive money creation.