Cryptocurrencies have transformed how we think about money. However, despite how common they are, many people do not understand a vital aspect of these assets — how their supply is managed. In traditional finance, the government and central bank control the distribution of money.
Well, things are quite different in the decentralized world. Cryptocurrencies rely on pre-written codes that determine how new coins are introduced into circulation. This is where the concepts of inflationary and deflationary crypto come into play.
In this article, I will break down what these words mean in the easiest way possible. I will also do a detailed comparison of inflationary and deflationary cryptocurrencies. Follow closely.
KEY TAKEAWAYS:
- Inflationary cryptocurrencies have an increase in their supply over time.
- Inflationary cryptocurrencies provide liquidity for growth while encouraging participation and development.
- Deflationary cryptocurrencies have either a fixed supply or a circulating supply that reduces with time.
- Deflationary cryptos usually have limited usability but often serve as hedges against inflation.
What Are Inflationary Cryptocurrencies?
These assets are designed to increase their total supply over time. In other words, coins are regularly introduced into the system by mechanisms like proof-of-work (PoW) or proof-of-stake (PoS). The goal is to sustain the network, maintain liquidity, and encourage participation.
Inflationary e-currencies do not have a fixed cap on their supply. Their amount increases according to a predetermined formula. For example, Ethereum previously generated new ETH tokens as block rewards for miners before the introduction of Ethereum 2.0. Similarly, Dogecoin supplies 5 billion DOGE every year.
Pros of Inflationary Cryptocurrencies
- Incentivizes participation: Miners and stakers who are rewarded with new coins are encouraged to secure and maintain the network.
- Provides liquidity for growth: Adding coins to the market encourages economic activity and adoption of the crypto.
- Encourages development: A growing supply allows developers to modify the incentives to suit the network’s needs per time. For instance, Ethereum used block rewards to support its ecosystem, which has led to the development of smart contracts and dApps.
Cons of Inflationary Cryptocurrencies
- Weakening of the coin’s value: If the demand does not match up with the supply, the coins can lose value with time. This can also negatively affect the interest of investors who consider inflationary crypto as less valuable due to lack of scarcity.
Read Also – A Beginner’s Guide to Investing in Decentralized Finance (DeFi)
What Are Deflationary Cryptocurrencies?
They are built on the principle of scarcity. Deflationary cryptocurrencies either have a fixed amount, or their circulating supply reduces over time. For instance, Bitcoin has a maximum supply of 21 million. On the other hand, Binance Coin (BNB) uses a certain amount of its revenue to buy back and burn BNB tokens. This scarcity often leads to increased value as their demand typically exceeds supply.
Pros of Deflationary Cryptocurrencies
- Hedges against inflation: Their supply model is typically seen as a safeguard against currency devaluation.
- Leads to price appreciation: Limited supply leads to price increases with time.
- Boost investor confidence: A predictable or decreasing supply attracts long-term investors who want stability.
Cons of Deflationary Cryptocurrencies
- Risk of centralization: A few holders might end up controlling most of the tokens if the supply decreases too much.
- Slow economic growth: Deflationary blockchains may struggle to provide incentives, which can limit participation.
- Limited usability: Investors may prefer to hold high-value coins rather than spend them, which may limit their usefulness as a currency.
The Journey From Deflationary to Inflationary Cryptocurrencies
Bitcoin, the first crypto, introduced the deflationary model when it was released in 2009. It prioritized scarcity, and, as stated earlier, its total supply was fixed at 21 million. Bitcoin is designed to mimic the scarcity of precious resources like gold through a process called halving.
Here, the reward for mining new blocks is reduced by half every four years. In fact, the last Bitcoin is expected to be mined around the year 2140. After that, miners will only be rewarded with transaction fees for their work of maintaining the chain.
As blockchain technology evolved, new coins began to emerge with the inflationary model. This new approach was developed to address issues like scalability, liquidity, and network participation. The evolution shows the dynamic nature of the industry and how it adapts to changing demands.
A Comparison Of Inflationary Vs. Deflationary Cryptocurrencies
Here is a quick overview of the differences between the inflationary and deflationary models:
| Inflationary | Deflationary | |
| Supply | Increases with time. | Fixed or decreases with time. |
| Impact on value | Potentially weakens the value. | Potentially boosts the coin’s value. |
| Use case | Encourages participation in the network. | Often used as a store of value. |
| Examples | Ethereum, Dogecoin, and Polkadot | Bitcoin, Binance Coin, and Ripple |
Which Model Is Better For Investors?
This largely depends on your investment goals and risk tolerance. As a general rule, if you want a coin with stability and long-term value, deflationary cryptocurrencies like Bitcoin might serve you. Alternatively, if you want high liquidity and the opportunity to earn network rewards, inflationary cryptocurrencies may be a better option. However, I advise that you consider diversifying into both categories of assets to have a balanced portfolio.
Conclusion
Inflationary and deflationary coins each come with their unique benefits and challenges. Indeed, the discussion is not to say one is superior to the other; it is to ensure your choice aligns with your financial goals. Make sure you understand how they work to maximize your profit while minimizing risks.
Reference
- cointelegraph.com – Inflationary vs. deflationary cryptocurrencies, Explained
- 101blockchains.com – What is the Difference Between Inflationary and Deflationary Cryptocurrency?
- bitstamp.net – Inflationary vs deflationary currencies
