Cryptocurrencies are financial instruments and they are affected by the force of fiscal and monetary policies. This article shares insights regarding inflationary and deflationary cryptocurrencies and highlights their differences.
What is an Inflationary Cryptocurrency?
Cryptocurrencies are said to be inflationary if they have an increasing supply over time. It means that if the total number of tokens continues to increase in the market, the cryptocurrency becomes inflationary.
It happens because as the total supply of a given cryptocurrency increases its price will dwindle. Inflationary currencies retain incorporate supply control mechanisms and manage their token distribution sequence in addition to specifying the inflation rate to incentivize investors.
What is a Deflationary Cryptocurrency?
Deflationary cryptocurrencies are the reciprocal of inflationary tokens in terms of their total supply. The overall supply of deflationary tokens continues to reduce over time. As a result, the unit price of the token continues to gain momentum on account of depleting the overall quantity.
Deflationary currencies adopt distribution retention mechanisms such as mining reward halvings, burning tokens, and sending gas to burn addresses. These currencies have a deflationary rate encoded in the native blockchains.
Difference between Inflationary and Deflationary Cryptocurrencies
Here are the main differences between inflationary and deflationary cryptocurrencies:
The total supply of an inflationary crypto project is usually infinite. However, it can also be capped to a maximum total limit in many cases. At the same time, the supply is also determined by the fixed or flexible protocol governance mechanism.
On the other hand, the total supply of deflationary tokens is fixed. The total supply of this type of cryptocurrency is fixed at maximum limit but it also depends on the governance protocol. A blockchain can incorporate a token-burning mechanism as an update or it may override the existing supply control mechanism by adding upgrades.
Inflationary tokens are usually designated as utility tokens. It means that they are intended for utilization for various purposes. At the same time, they are also used as a medium of exchange and for conducting transactions.
On the other hand, deflationary cryptocurrencies are used as a store of value and a hedge against inflation. They are more suitable for investment ventures rather than trading.
Inflationary cryptocurrencies are not ideal for holding for long-term duration. It means that these currencies incentivize investors by utilization such as in day-to-day transactions.
On the contrary, deflationary currencies are good for long-term reserves as their value tends to increase with time. At the same time, their profits can diminish for short-term positions.
The value of inflationary tokens is incentivized based on the internal changes and requirements of its native protocol. Meanwhile, deflationary currencies are useful as a hedge against inflation and a good remedy for combating hyperinflation.
The monetary policy related that governs the inflationary tokens is often flexible. On the other hand, deflationary cryptocurrencies ensure scarcity and increased adoption over time.
The purchasing power of inflationary and deflationary token holders can either increase or decrease over time. Nevertheless, it is more likely that the purchasing power for inflationary currency holders diminishes over time on account of its flexible coin creation mechanism.
However, purchasing power for deflationary token holders may distinguish on account of fixed supply governance.
The liquidity for inflationary currencies can increase over time since they continue to increase in numbers.
On the other hand, the rule is reversed for deflationary currencies; it means that their liquidity can diminish as time passes since they adopt mechanisms to reduce their total token supply using coin burning and other methods.
Cryptocurrencies can be inflationary and deflationary at a given time such as Bitcoin and Ethereum. Some aspects of Bitcoin are inflationary in that that it continues to mint new tokens and add them to circulation via miners.
Meanwhile, Bitcoin is also deemed as an inflationary token on account of features like halving that slash miner rewards by 50% after every 4 years.
On the other hand, Ethereum was also wholly inflationary before the merger event. Post, the merge event, the total token supply diminished on account of a shift to PoS and smaller rewards for network validators.
Another inflationary feature of Ethereum is that it has an infinite total supply but the annual supply limit for ETH is capped at 18 million.
Inflationary and deflationary cryptocurrencies are useful under different market conditions and they are suited for different trading activities. However, one crypto project can have both inflationary and deflationary features.
Investors can upgrade their trading strategies by keeping in view the inflationary and deflationary aspects of a given crypto coin.