Inflationary and Deflationary Cryptocurrencies: Main Differences

  • Crypto Guru
    September 13, 2023, 13:22

Cryptocurrencies can be either inflationary or deflationary – it depends on how their total supply changes over time. The total supply of a currency may be increasing because there is no limit on mining, so these cryptos are inflationary. As a rule, there is a predetermined rate of inflation. Deflationary currencies, conversely, have a finite supply – it is not possible to mine these coins infinitely, so inflation stops at some point, and their value increases.

Cryptocurrencies are an alternative you can invest in when you don’t want to put your money in fiat, but crypto is still not a perfect hedge against inflation. In this article, the experts at Grapherex share their knowledge of how crypto works today.

Inflation in Crypto

Inflation means that you can buy less with the same amount of money. That is, with each unit of currency, a US dollar, a euro, a pound, or an Ether, you can buy less than you used to. It works the same way with fiat and inflationary cryptocurrencies. However, there is one way to combat inflation in crypto – this involves deflationary currencies with limited inflation times and fixed hard supplies.
There is a period of high inflation (about 10%) in the UK now, and since 2022 the Bank of England has been increasing interest rates to reduce inflation rates and avoid a recession. The same measures were taken in the US and other countries. With the current issues with inflation globally, deflationary crypto may be a great choice to safeguard your investments.

Disinflationary Measures vs Deflationary Currencies

Before we go further, let’s note that disinflation and deflation are not the same.
Disinflation is a term meaning when inflation slows down or continues to inflate, but not at the same rate as before. Disinflation is a reduction in the level of inflation, but not a reversal of it. Central banks establish disinflationary policies to reduce the rates, but they are not making inflation disappear totally.

Deflation is the opposite of inflation, meaning that the prices of goods decrease, which means that everything becomes cheaper. At first glance, this may seem like a good thing since you could get more for your money, but in fact, deflation is a concern. Although deflation throughout history was perceived as essentially good or neutral, it has many dangerous consequences, such as slowing down economic growth.

But this refers more to decisions at the governmental level. Let’s now have a closer look at personal use and discuss cryptocurrency specifics.

What Does Inflationary Currency Mean?

Inflationary cryptocurrencies decrease in value with time as their total supply increases. Cryptocurrencies like ETH, Solana, DOT, and Dogecoin are inflationary.

Cryptocurrencies operating on an inflationary model use specific consensus mechanisms like proof-of-work (PoW) or proof-of-stake (PoS) to distribute newly minted coins amongst participants on their network. Depending on the cryptocurrency, these new coins can be mined by users (like in the case of Bitcoin) or rewarded to validators on the network (as is done with Ether).

In all cases, there are more and more crypto coins released onto the market, and if the demand is stable or falls, the price is likely to go down. This is a classic inflation that works with all kinds of money, including fiat. But, unlike central banks, which can print fiat money, the way new cryptocurrency tokens are made is transparent and predictable. Thanks to the public nature of blockchain systems, the market can adapt to any changes in advance.

What Does Deflationary Currency Mean?

Deflationary cryptocurrencies increase in value with time as total supply remains constant or decreases. Common examples are BTC, BNB, Shiba Inu, and Polygon.

Deflationary currencies often encode a predetermined deflation rate. For instance, there may be implemented an annual deflation rate of 2.5% resulting in a yearly reduction of the currency’s total supply by 2.5%. Usually, when the supply limit is attained, no more tokens can be minted; thus, the demand for them increases, which eventually leads to an increase in value. However, there are exceptions to this rule. The tokenomics of deflationary cryptocurrencies is significantly impacted by the incentives of stakeholders – miners, developers, and users.

Are Deflationary Currencies Better?

Deflation is not always good, even though it means that prices decrease and the purchasing power of money grows. In fact, when deflation is seen in developed countries like Japan, and the government does not stimulate people to spend money or invest, the economy just goes down.

Other economies with inflationary policies and moderate levels of inflation outperform those with deflation, as there is economic growth and, at the same time, a slight increase in price levels.

So, there is no black and white here – we cannot say that only deflationary currencies are good. They have different tokenomics and governance mechanisms and are used for different purposes. Inflationary currencies are used for daily transactions, while deflationary ones perform the best during long-term investments.

Is Bitcoin Inflationary or Deflationary?

Bitcoin is technically an inflationary asset. Over time the supply of Bitcoin increases – new coins are continuously mined and enter the supply, even though there is a halving once every few years. Such disinflationary measures affect BTC’s scarcity and reduce inflation over time.

But there is a strong argument for BTC being deflationary. The supply of BTC is limited – the 21 million cap means that when all coins are mined, no more will be added to the market. BTC will reach its hard cap around the year 2140.

Is Ether Inflationary or Deflationary?

That’s a topic of debate. The programmed reduction of the token creation rate, adoption of PoS, and growing utility of ETH in the DeFi ecosystem point towards a deflationary trajectory.

Ether serves as the transactional currency for decentralised applications (DApps) developed in the Ethereum ecosystem. Although there is no limit on the total supply of ETH, and currently, it is considered inflationary, the rate of new coin issuance is designed to decline gradually.

Inflationary vs Deflationary Currencies

Let’s sum up everything we’ve learned so far and add several more criteria for cryptocurrency evaluation. Here is how they differ from each other:

Key Takeaways

  • Inflationary currencies can be mined infinitely; their supply is unlimited. Since there are more and more coins and tokens coming onto the market, their value and demand decrease, and there is inflation.
  • Deflationary currencies have limits on their supply. For example, Bitcoin has a strict limit of 21 million BTC available for mining. They will cease to be added to the market at one point in time, and the supply will not grow, but their value will – there will be no inflation.
  • Ether is now inflationary; however, its value will grow, and the rate of mining new coins will decline, so there is a clear deflationary trend.
  • All fiat currencies and most of the utility cryptocurrencies are inflationary.
  • Both deflation and inflation are topics of concern, and policymakers pay close attention to them, changing the system and interest rates to mitigate any related problems.