Inflation is one of the most troubling economic phenomena, especially for countries like the United States, which has the world’s highest inflation rate. For the fiscal year that ended in June 2022, the annual inflation rate in the United States peaked at 9.1%. This rise in inflation is especially noteworthy, given that the inflation rate peaked at 7% in 2021.
Rising inflation has caused not only wage stagnation but also an increase in the prices of goods and services. As a result, there is currently more debate than ever about whether cryptocurrencies will cause inflation or deflation.
Many believe using cryptocurrencies to hedge against rising inflation is a good idea. It is important to note that cryptocurrencies can act as both inflationary and deflationary assets.
Can cryptocurrencies help stop inflation?
This article works through this open question by thoroughly exploring inflationary and deflationary cryptocurrencies and highlighting their differences.
The Significance of Supply Limits
Supply limits determine whether a cryptocurrency will be inflationary or deflationary. A supply limit is the maximum amount of a particular coin or token that can be put into circulation.
This varies based on the particular cryptocurrency. For instance, unlike Ethereum, which has no supply limit, Bitcoin has a supply limit of 21 million BTC.
A supply limit seldom changes, and it impacts how a cryptocurrency performs on the market.
The Difference Between Inflation and Deflation
When there is an excess of currency in circulation, the value of the currency falls, causing the price of goods and services to rise. This economic phenomenon is referred to as “inflation.”
Deflation, on the other hand, is defined as an increase in the value of a currency coupled with a corresponding decrease in the price of goods and services. It is important to remember that a scarcity of money results in deflation.
Inflation can be beneficial in some situations because it stimulates economic growth by encouraging consumer spending. Conversely, inflation can also become a serious issue when prices rise faster than wages.
The main distinction between deflation and inflation is in the currency supply. The supply of fiat currency can be increased when the need arises, though this often causes inflation. Since overall economic activity is always constant, the value of a single currency unit declines. Deflation implies lower demand and increased supply, which may increase the purchasing power of fiat money.
What is an Inflationary Cryptocurrency?
In an inflationary environment, the total amount of money in circulation increases over time. As a result, money capital loses value, and the value reflected in currency decreases. The same thing happens with cryptocurrencies, which are forms of digital money. When more tokens are in circulation, the cryptocurrency is said to be inflationary.
Dogecoin is an example of an inflationary cryptocurrency. One of the cryptocurrency’s founders removed a 100 billion hard cap in 2014 to guarantee an endless supply of the cryptocurrency. Its value has fluctuated significantly over time. The coin soared on May 7, 2021, reaching an all-time high of $0.64. The value of the token reached $0.30 a few days later. The price is currently close to $0.066.
The Ethereum network’s Ether is another example of an inflationary cryptocurrency. However, in August 2021, an update required that some ethers be burned whenever network traffic increased in order to make the coin deflationary.
What is a Deflationary Cryptocurrency?
A deflationary cryptocurrency is one whose supply gradually decreases, limiting the quantity in circulation and ultimately raising the currency’s value. There are two ways in which the supply is reduced.
One method is buyback-and-burn, in which developers repurchase a significant number of bitcoins and send them to a dead wallet (a process also known as “burning” in crypto) so that they are no longer in use.
The second method involves the use of transaction fees, also known as “burn-on” transactions. The currency’s contract states that the tax imposed on all on-chain transactions involving that coin will be destroyed and removed from circulation.
Differences Between Deflationary and Inflationary Cryptocurrencies
Value
The difference between deflationary and inflationary cryptocurrencies demonstrates that deflationary cryptocurrencies would appreciate over time due to scarcity. However, it’s important to remember that demand is also a critical factor in determining how much deflationary cryptocurrencies are worth.
Contrary to popular belief, a lack of demand would result in a significant decrease in the value of an asset. Considering inflationary cryptocurrency values, you might not get much right now.
On the other hand, the true value of cryptocurrencies is found in various use cases, such as the well-known example of Ether for DeFi applications.
Conversion
Another key distinction between the two types of cryptocurrencies is the ability to convert assets from inflationary to deflationary.
Because they are intrinsically inflationary, inflationary cryptocurrencies have an infinite supply. However, the inflationary vs. deflationary cryptocurrency debate must focus on how inflationary cryptocurrencies can temporarily become deflationary cryptocurrencies.
In some cases, inflationary cryptocurrencies can impose deflationary mechanisms to combat inflation. For example, Ethereum, which uses the inflationary coin ETH, burns a certain percentage of its tokens during periods of high activity.
Deflationary cryptocurrencies, on the other hand, cannot be arbitrarily created because they are naturally deflationary. The specific examples of deflationary cryptocurrencies show how they use various processes or constraints to limit the number of tokens in circulation.
Supply
Supply is the most obvious factor in the inflationary vs. deflationary cryptocurrency debate. The change in the supply of the native coin is what distinguishes deflationary cryptocurrencies from inflationary ones. An inflationary cryptocurrency has more tokens in circulation due to an increased supply. A deflationary cryptocurrency, on the other hand, has a lower quantity of coins.
Purchasing Power
One obvious observation is that an inflationary cryptocurrency has less purchasing power.
The value of a specific cryptocurrency falls when it has more tokens in circulation. On the other hand, the limited supply of a deflationary cryptocurrency would increase its value. The price of the deflationary cryptocurrency may rise in response to rising demand and reduced supply.
Fastest Growing Deflationary Cryptocurrencies in 2022
Litecoin (LTC)
Litecoin (LTC) undergoes a halving procedure every four years, just like Bitcoin. The coin’s supply also has a hard cap of 84 million units.
Binance Coin (BNB)
Binance employs the buyback-and-burn strategy to decrease supply. It buys back BNBs from investors who gained more than 20% in the previous quarter and sends them to a dead address to remove them from circulation.
Cronos (CRO)
Cronos (CRO) is the native token on Crypto.com (a popular cryptocurrency platform). The cryptocurrency has a limited supply of 30 billion tokens in circulation.
Polygon (MATIC)
MATIC is the native token of the Polygon blockchain. This token is primarily used to pay transaction fees and to participate in the Proof-of-Stake (PoS) consensus program. Burning a portion of each block’s transaction fees aids in the preservation of MATIC’s value.
Solana (SOL)
Solana is a cryptocurrency that is both inflationary and deflationary. It is an inflationary token because its supply is unlimited. Also, the coin’s miners burn transaction fees, making it deflationary.
Ripple (XRP)
Ripple is the default currency of the RippleNet platform, which levies transaction fees to limit supply. The fact that these fees are burned rather than returned to the central authority or used to pay validators makes XRP a deflationary cryptocurrency.
PancakeSwap (CAKE)
CAKE, the native cryptocurrency of the PancakeSwap platform, has no maximum supply, making it an inflationary coin. CAKE is also deflationary because it employs a coin burn mechanism.
The Benefits and Drawbacks of Inflationary and Deflationary Cryptocurrencies
While some investors prefer deflationary cryptocurrencies over inflationary ones, the reality is that each type of cryptocurrency has benefits and drawbacks. While inflationary cryptocurrencies may cause demand to exceed supply, they allow the mining industry to continue indefinitely.
Deflationary cryptocurrencies, however, provide the benefits of a price spike, which is also a huge advantage for investors. Only time will tell if such cryptocurrencies will indeed experience such a rise when their limits are inevitably surpassed.
In Conclusion,
- The debate between inflationary and deflationary cryptocurrencies can provide insight into the cryptocurrency world.
- In essence, the distinctions between inflationary and deflationary cryptocurrencies reflect the fact that the supply of a cryptocurrency influences its value and purchasing power.
- Because of supply and demand dynamics, even the cryptocurrency market is vulnerable to inflation and deflation constraints. However, it is critical to note the methods for converting inflationary cryptocurrencies into deflationary ones, such as sacrificing tokens or imposing supply restrictions.
- Before investing in cryptocurrencies, investors should understand the distinctions between inflationary and deflationary cryptocurrencies.
- Finally, it is critical to fully comprehend the risks associated with cryptocurrencies.
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