By Larry Wright
Supply mechanisms may be thought of as the procedures that are used to characterize the provision, addition as well as elimination of virtual and tangible assets from the market circulation. When discussing cryptocurrencies, “supply” refers to the total quantity of currencies or tokens that have existed in the past and, therefore, will be available in the future, in addition to the process by which more coins or tokens may be introduced to or withdrawn from distribution. In order to fully grasp the impact of supply dynamics on financial choices made by individual traders, we will now investigate two distinct forms of supply processes, namely inflation and deflation.
Both inflation as well as deflation are considered to be some of the most significant financial phenomena associated with fiat currencies. This is mostly attributable to the fact that inflation and deflation have a significant impact on all stages of economies. From the micro and macro levels, all are heavily influenced by these two related terms.
Indeed, it is of the utmost significance to have a solid understanding of both inflation and deflation since both have the potential to have a significant impact on a user’s financial situation as well as the whole regulatory environment on both the national and international scale. There are a variety of catalysts and factors that are responsible for this monetary inflation and deflation, and each of them is quite different from the next.
In the present economic landscape, cryptocurrencies form a pivotal section of the financial market, and just like other tangible assets, they are affected by inflation and deflation too. This is why elements that are intrinsic to cryptocurrencies were specifically developed to provide protection against the widespread deflation and inflation that may occur in fiat economies. Examples of this include Bitcoin (BTC), which has an inherent limit on the number of coins that may ever be issued due to a predetermined limit (max 21 million BTC).
Nevertheless, despite having a restricted quantity, currencies such as Bitcoin are still considered to be deflationary commodities. In contrast, coins with an unpredictable production, such as Ethereum, are considered to be inflating investments. It is essential to have a solid understanding of both inflation and deflation so that you can have a clear grip on the differences between the two. So, before we understand what deflationary or inflationary cryptos are, let us first try understanding what “inflation” and “deflation” mean in actuality. Let’s get started!
Inflation vs. Deflation
When there is a high quantity of any currency or asset available, its value declines, and its purchasing power is reduced; this is known as inflation. Conversely, deflation occurs when there is a shortage of a currency, and its value or purchasing power rises as a result. Fiat currencies, also known as conventional economies, are primarily inflationary due to the fact that financial institutions have the ability to continually raise their supply contingent upon the demand in the prevailing market.
Digital money or cryptocurrencies are primarily deflationary in nature as there’s always a limited amount of crypto that could be mined; it can’t be mined endlessly as it is restricted in its supply. With inflation showing no signs of slowing down anywhere in the world, the question of whether or not cryptocurrencies are inherently inflationary or deflationary is becoming more hotly contested.
If you feel overwhelmed by these terminologies, there is no need for you to worry. In this post, we’ll compare and contrast inflationary and deflationary cryptocurrencies, discussing their respective merits and limitations in the battle against inflation, and offering guidance on how to make the best choice.
What are Inflationary Cryptocurrencies and How Do They Work?
As more and more people look to cryptocurrency as a way to protect their wealth from inflation, it’s crucial that they understand the risks and benefits of both inflationary and deflationary assets. Due to the fact that bitcoins and other cryptocurrencies are regulated by stringent protocols encompassing supply and demand, it is possible for virtual currencies to experience both inflationary and deflationary pressures at the same time.
A virtual currency that has a rising number of tokens in existence is said to have inflationary characteristics. Mining, holding, staking as well as other practices that are becoming more widespread for the purpose of producing new currencies, may all contribute to an increase in the total number of tokens that are in circulation. The price of the currency continues to level down as more of them are produced and incorporated into the existing circulation. Because of this, customers need to pay a greater quantity of tokens in order to acquire a certain good, commodity, or object.
In the argument between inflationary and deflationary coins, Dogecoin stands out as the most compelling illustration of the inflationary kind. In the year2014, one of the developers of Dogecoin relaxed the strict limit on the total production, which had been set at 100 billion DOGES primarily. This action was taken with the specific intention of assuring that there is an inexhaustible availability of the commodity.
As a result, there is a greater likelihood that the production of the token will exceed the desire for it, which would result in a decrease in the worth of all Dogecoin currencies. However, there are also inflationary products that have inflation up to a predetermined cap. Let us consider Bitcoin as one of the examples.
It is fascinating to note that Bitcoin has included a novel technique for halving the inflationary pressures, which has the consequence of damping down inflation. The Bitcoin community will, on average, restrict the total amount of coins that may be mined and put into existence by a two-to-one ratio every four years.
You might be confused by the notion of how 19 million bitcoins are already mined and how little is time left to mine the remaining. However, if you consider how mining incentives have been decreasing over the course of years, you might be able to reason that 21 million thresholds won’t be reached any time soon.
Due to the significant decrease in mining compensation, bitcoin occupies a delicate balance between being an inflationary and a deflationary coinage. For illustration purposes, the processing compensation for the year 2016 totaled approximately 12.50 Bitcoins. The 2020 payouts were reduced to about 6.25 Bitcoin, while the 2024 payouts will be rounded down to 3.125 BTC. The number of cryptocurrency tokens that are currently in circulation may be effectively reduced by using the halving method. As you see; the incentives are being constantly lowered.
What are Deflationary Cryptocurrencies and How Do They Work?
Cryptocurrencies are said to be deflationary if their total quantity is expected to fall throughout the course of their existence. As a result, the valuation of each coin would go up even in circumstances when demand remained relatively stable. However, several programs use various deflationary approaches to accomplish various ends. Binance, a cryptocurrency exchange, is mentioned as an illustration of a cryptocurrency that showcases deflationary cryptocurrencies.
Every three months, the trading platform restricts the number of its coins by destroying a small number of its native Binance Coins, also known as BNBs. In a comparable pattern, the cryptocurrency exchange Polygon destroys its own native MATIC currencies in order to lower the total number of tokens in circulation.
In conjunction with this, you are required to educate yourself on the many instances of digital currencies where that operate as monetary authorities or central banks. These types of cryptocurrencies keep the valuation of their tokens stable by a combination of inflationary and deflationary economic policies. Cryptocurrencies like TerraUSD and UST, which are steady and don’t fluctuate in value, are prime examples of deflationary cryptocurrencies. TerraUSD, also known as the Terra Network, is a stablecoin whose price is kept at $1 by minting and destroying the number of existing tokens.
Your comprehension of cryptocurrencies that are inflationary as opposed to those that are deflationary should likewise center on the idea that Ethereum is a deflationary digital asset. When Ethereum was launched, its inaugural cryptocurrency, Ether, was a highly inflationary resource.
On the contrary side, Ethereum released an upgrade in August 2021 that declared that Ether would deflate if there was an increase in the amount of its associated internet engagement. The upgrade included a provision for the destruction of ETH in order to lower the available supply of this digital asset. A monitoring database has shown that more than 1.7 million Ether currencies have likewise been eliminated in order to keep up with deflation.
How are Cryptocurrency Markets Effected by Inflation and Deflation?
Because cryptocurrencies are currently not as intertwined in the financial system and are constructed fundamentally, their connection to inflation and deflation is distinct compared to that of fiat currencies, which are widely used today. Nevertheless, the values of cryptocurrencies may be impacted by deflation and inflation, in line with the buying power and demand of the general population. We will be using Bitcoin, as an illustration, to demonstrate how exactly inflation and deflation might influence a cryptocurrency, as well as how these processes operate inside cryptocurrencies.
To begin, it is important to point out that Bitcoin is a deflationary commodity due to the fact that its quantity will never increase as it has a restricted supply. There is also a built-in inflation mechanism in the manner of “halving,” which reduces the available Bitcoin supplies and causes inflation by growing the market and demand for BTC.
Whenever the Bitcoin mining incentive is cut in half, the inflationary rate for Bitcoin is likewise cut in half, as does the pace at which freshly generated Bitcoin is introduced into circulation. This process is referred to as “halving.” When there is inflation, there is a rise in the total amount of money in circulation. As a result, the value of one bitcoin in terms of the national currency will increase whenever the global financial system as a whole contains a greater quantity of money.
However, the value of one bitcoin is likely to decrease in the eventuality that the market experiences deflation. The COVID-19 pandemic is one occurrence that demonstrates this phenomenon as we all know how much the value of BTC decreased as this disaster affected our globe.
The decrease in prices that occurred throughout this time period was caused by the fact that individuals who were under lockdown spent lesser money as they were already struggling with their health and other expenditures, whereas companies kept their administrative costs and inventory levels the very same. Coincidentally, the value of Bitcoin fell. Many investors needed funds and therefore cashed out their bitcoins, while others accepted the inevitable decline in value of their Bitcoin holdings as a result of the ongoing epidemic.
Moreover, it should be noted that if there is a less government-issued currency available, then the value of Bitcoin would most likely rise in response. The most important element to bear in perspective is the fact that the production of new currencies is a standard that Bitcoin adheres to. The inflationary and deflationary tendencies impacting Bitcoin do not connect with one another in a straight way, and they should be evaluated in terms of the larger economy as a whole.
Fixed vs. Floating: How are These Linked to Inflation and Deflation?
Now that we have an understanding of what inflationary and deflationary cryptocurrencies are let us have a quick look at one very important factor affecting these two economic phenomena, namely fixed and floating.
The price of conventional currencies, often known as fiat currencies that were in circulation, did not fluctuate significantly during the earlier days of our history. This happened because the values of historical currencies were traditionally and almost always tied to something tangible, most importantly, the gold holdings that were kept by financial organizations.
It was common practice to determine the total worth of such monies based on the aggregate amount of gold that could be purchased with such monies. Back in the day, people even had the ability to go to the administrations of their respective regions and make a requirement for a portion of the gold that was truly equivalent to the sum of currency they primarily possessed.
When the 1970s came around, financial institutions disregarded everything surrounding the idea of gold reserves, which ultimately contributed to the vast majority of nations entirely discontinuing the custom. When this occurred, the value of money became dependent on how it behaved in comparison to the values of other economies. This continued for a pretty long period of time until currencies were permitted to wander independently.
The term “fiat currency,” which comes from the Latin word “let it be done,” is employed to refer to monies whose value is determined not by the traits that are inherent to the money itself but rather by a mutual consensus. Because of this, monetary systems became largely inflationary when the standard for establishing the currency’s worth was thereby eliminated. The financial institutions in today’s economy are permitted to generate new currency anytime they feel it is necessary, and they are not compelled to tell the general populace about their activities. This freedom comes at the expense of transparency along with a decrease in the worth of such currencies, which are produced endlessly.
Nevertheless, authorities and national banks are unable to regulate the buying and selling of cryptocurrencies because of their decentralized nature. They are geared up with calculations and one-of-a-kind innovations that ensure an ideal availability that is not permitted to be exceeded so that it can never be said that they are subpar. Likewise, when the availability reaches that pre-set constraint, the production would halt, and the value would go anywhere.
However, the worth of such a coin still continues to be the same. This remains the case even if there is a further expansion in the marketplace for the currency and more and more people are purchasing it. In light of this quality, Bitcoin and other virtual currencies are prime instances of deflationary financial occurrences.
Conclusion
Both inflationary and deflationary cryptocurrencies come with their very own set of advantages and disadvantages. When it pertains to inflationary coins, they help generate a market situation where the demand for the currency is finally able to overweigh its supply. On the opposite side, speculators may find it easier to profit from the advantages related to price rises by purchasing deflationary cryptocurrencies.
Although some investors choose deflationary cryptocurrencies over inflationary ones and conversely, the fact of the matter is that each type of cryptocurrency has both positive and negative aspects to them. In spite of the fact that inflationary cryptocurrencies might lead to a demand-over-supply situation, these cryptocurrencies do make it possible for the mining business to persist eternally.
However, deflationary cryptocurrencies provide the possibility of a price increase, which is a significant advantage for speculators. Nevertheless, only time will determine which of the two classes of cryptocurrencies will really see a rise of their demand in the general market.