Inflation and deflation, both terms in financial terminology, are among the most troubling words in any economy.
Prices of commodities are rising sharply while wages remain stagnant, meaning inflation is at its peak globally. With crypto prices falling sharply, investors who believed that Bitcoin and cryptocurrencies were an essential hedge against inflation wonder if they made the right choice.
Inflation vs. deflation
Inflation happens when a currency’s supply gets so high that it loses its value or buying power. Deflation, on the other hand, refers to the situation where a currency’s value or buying increases in reference to short supply. Fiat or traditional currencies are mainly inflationary since central banks can and constantly increase their supply. Cryptocurrencies, on the other hand, are primarily cryptocurrencies deflationary in one way or another.
As inflation continues to bite globally, the debate between inflationary vs. deflationary cryptocurrencies is gaining momentum. Don’t fret if you find these terms overwhelming. Our article will dissect the subject of inflationary vs. deflationary crypto assets, explain the difference between them, whether they can fight inflation and why you must pick the right one.
What are Inflationary Cryptocurrencies?
The main feature of inflationary cryptocurrencies is their increasing number of tokens. While the token’s value would generally grow as the supply increases, you would require more tokens to purchase over time. There are different standard methods of increasing the supply of tokens, including mining and crypto staking, to name but a few.
Dogecoin (DOGE) is an excellent example of an inflationary vs. deflationary cryptocurrency debate. The creators removed a hard cap supply of 100 billion DOGE in 2014 to ensure an unlimited supply of the cryptocurrency. As a result, the supply can exceed demand which can quickly reduce the token’s value.
The creators of Bitcoin (BTC), another inflationary, designed it to have a limited inflationary effect. BTC has a hard cap of 21 million tokens, meaning that once the level is reached, you can no longer mine more Bitcoin. Once the peak level has been arrived at, BTC will automatically convert into a deflationary cryptocurrency.
So far, over 19 million Bitcoin have been mined already, but it’s projected that it could take decades until the final token is mined. That’s because of a process known as halving, which happens at least once every four years, continuously reducing the number of tokens that can be mined and put in circulation. Unlike DOGE, BTC has employed a unique mechanism that helps slow inflation down; the method is known as halving.
What are Deflationary Cryptocurrencies?
Deflationary cryptocurrencies are designed so that their supply reduces with time. Subsequently, the value of every such token is projected to increase as long as the demand remains constant, with different cryptocurrency projects employing varying deflationary metrics. A precise knowledge of deflationary cryptocurrencies will help you appreciate the difference between inflationary vs. deflationary cryptocurrencies.
Cryptocurrency exchanges Binance and Polygon offer the best examples of how cryptocurrency projects deal with deflationary cryptocurrencies. Binance exchange destroys a given number of its native Binance coins (BNB) once every quarter to keep its supply in check. Polygon exchange also “burns” many of its MATIC native tokens for the same reasons. It is projected that once the collection of any coin can no longer meet its demand, prices will go up.
Inflationary vs. Deflationary
The economic effects tied to the inflation and deflation of traditional currencies may not be as clear and straightforward to most people. However, understanding the factors that affect the concepts is easier to explain when explaining inflationary vs. deflationary cryptocurrencies.
While inflationary cryptocurrencies feature a system that promotes continuous growth in the number of coins in supply, deflationary cryptocurrencies feature a system where the supply of tokens in circulation reduces gradually over time.
If you’re going to differentiate between inflationary and deflationary cryptocurrencies, some of the factors you want to consider are the following.
Fixed vs. floating
For a long time, the value of fiat or traditional currencies used to be fixed because their value was almost always tied to something tangible, especially gold reserves held by central banks. The value of such coins was commonly defined as the amount of gold they could purchase. There was a time in the past when citizens could visit banks and demand a portion of the gold that was equivalent to their deposits.
Enter the 1970s, and central banks forgot about gold reserves, so most countries abandoned the practice entirely. Currencies then became floating, meaning their value became dependent on comparison to other currencies. Currently, the value of traditional currencies is mainly based on a general agreement that they have a value, which is the genesis of the term fiat currencies, borrowed from the Latin term “let it be done.”
The main undoing of trashing the gold standard for fixing the value of money is that it made fiat currencies mainly inflationary. Today, central banks can print new currency as they see fit and don’t have to make public announcements about it. The value of any currency is affected by the amount in circulation, meaning that the greater the amount in circulation, the lower the currency’s purchasing power.
On the other hand, cryptocurrencies are not controlled by any government or central banks. They have algorithms and unique mechanisms that ensure a maximum supply that can never be exceeded. Once the supply reaches that pre-set limit, the supply will halt, and the value will go anywhere but up as long as the token’s perceived demand remains constant. That factor makes cryptocurrencies such as Bitcoin and others genuinely deflationary.
The deflationary nature of most cryptocurrencies allows people to HODL them relentlessly, which makes buying crypto quite expensive. Take note, though, that there are other cryptocurrencies, such as those that run on proof-of-stake (PoS) consensus mechanisms that don’t have a maximum supply.
Ethereum (ETH) is one such cryptocurrency developing toward the PoS structure, even though that doesn’t necessarily make it an inflationary cryptocurrency. However, unlike central banks that can print currencies at will, the method of creating new cryptocurrencies is transparent and predictable, thanks to the public nature of blockchain technology.
Demand and Supply
Supply and demand are essential when choosing between inflationary and deflationary cryptocurrencies. The truth is that the increase or decrease of collection creates a difference between the two types of crypto tokens.
It’s good to remember that even inflationary cryptocurrencies can have several significant benefits in dealing with inflation. A good example is where inflationary cryptocurrencies cause a scenario where demand eventually overpowers supply. Deflationary cryptocurrencies, on the other hand, can help investors capitalize on the benefits associated with price increases.
Unlike inherently inflationary fiat currencies, we have already realized that while most cryptocurrencies may appear inflationary as they develop, they are designed to transition from inflationary to deflationary.
The ability to convert themselves from inflationary to deflationary cryptocurrencies not only gives them an edge over fiat currencies but also ensures that cryptos that developers can always make changes to transform inflationary cryptocurrencies into deflationary ones.
When dealing with economic inflation, users can deploy deflationary mechanisms into inflationary cryptocurrencies to help contain inflation. A good example is ETH, which is mainly an inflationary cryptocurrency that could choose to burn a given number of tokens during times of high activity.
Let’s chew this further so we can make it clearer to you. The ability to convert from inflationary doesn’t necessarily make inflationary assets with an unlimited supply of coins inherently bad ones. Such coins like DOGE and ETH may experience high supply and low demand every once in a while. You want to remember that, unlike the fiat currency setups, their crypto ecosystems are designed to override economic downturns.
Ethereum is an unlimited currency without a hard cap. However, the Ethereum blockchain has been programmed to limit the amount of ETH miners can mine within a year. If, for example, the supply of ETH, according to the market cap, is 100 million, miners can only mine 18 million ETH annually, translating to an inflation rate of 18%.
However, suppose ETH’s market cap increases to 200 million tokens. In that case, the 18 million fixed amount of ETH that can be mined will translate to an inflation rate of 9%, which will benefit the Ethereum ecosystem. Therefore, this tells you that as far as inflationary vs. deflationary cryptocurrencies are concerned, an inflationary profile is not necessarily bad.
Such action is almost impossible on cryptocurrencies designed as strictly deflationary since no one can create or burn any tokens at will. That is because, by nature, deflationary cryptocurrencies have their unique mechanisms that restrict the number of coins that can ever be in circulation.
The value of particular digital assets is an important aspect to consider when comparing inflationary vs. deflationary cryptocurrencies. On how they differ in value, there’s every chance that since they could eventually become scarce as far as supply vs. demand is concerned, deflationary cryptocurrencies are likely to have a higher value when the right time comes, which makes them a good investment vehicle.
The most important thing you want to remember, though, is that whether the value of deflationary cryptocurrencies will ever spike depends on the critical issue of demand. Should the demand for deflationary cryptocurrency remain dismal now or in the future, that could significantly curtail such a digital asset’s potential to become valuable now or in the future.
Therefore, a cryptocurrency’s intrinsic value primarily rests on whether it can potentially have diverse use cases. ETH is an excellent example of such a cryptocurrency, considering how it has established itself as the cryptocurrency of choice for Decentralized Finance (DeFi) and non-fungible tokens (NFTs).
In macroeconomics, any currency designed to have new units released easily and arbitrarily becomes inflationary. That means it becomes a force that can materially influence the production and consumption of goods and services in a given economy. The high volume of such a currency will also determine the prices of commodities in a market.
The units needed to purchase items become fewer when there are low currency supplies. On the other hand, buyers pay higher for the same thing when the market is flooded with units of a particular currency. Similarly, the purchasing power of inflationary vs. deflationary cryptocurrencies is determined by the number of tokens of the specific cryptocurrency in circulation.
The greater the number of coins of any cryptocurrency in circulation, the lower the value. In the case of deflationary cryptocurrencies, which are in limited supply, they have greater purchasing power due to their higher valuation. So long as the reduced supply goes hand in hand with increased demand and potential for growth, deflationary cryptocurrencies will be priced better and purchase more.
The Parting Shot
According to the traditional definition of inflation, Bitcoin and other cryptocurrencies are inflationary currencies. However, their inflation rates are easily understood, almost predictable, and constantly decreasing. And just like gold, the inflation rate of cryptocurrencies will someday reach zero point.
However, when you consider the mainstream definition of inflation, Bitcoin and most other cryptocurrencies are inherently deflationary, especially since their purchasing power is expected to continue increasing over time.
While Bitcoin’s purchasing power may still be wildly volatile, both inflationary and deflationary cryptocurrencies are still relatively new and expected to stabilize in the long run. The total supply of deflationary cryptocurrencies like BTC is fixed, which guarantees their purchasing power will increase as long as the demand exists.
In choosing between inflationary vs. deflationary cryptocurrencies, it’s obvious that both types of crypto have their pros and cons. Inflationary cryptocurrencies may lead to a demand-over-supply scenario, which could indefinitely sustain the crypto mining industry. Nonetheless, deflationary cryptocurrencies may result in a price spike, which would greatly benefit investors. Only time will tell which among all those crypto tokens will thrive when they eventually reach their limits.