Cryptocurrency Inflation and Deflation

Inflationary cryptocurrencies are those whose purchasing power declines over time due to increases in supply. In contrast, deflationary cryptocurrencies increase in intrinsic value over time as their total supply remains constant or decreases

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What are Cryptocurrency Inflation and Deflation?

Cryptocurrency Inflation and Deflation

Cryptocurrency inflation and deflation refer to how the overall purchasing power of a specific cryptocurrency changes over time. Inflationary cryptocurrencies have declining purchasing power over time due to increases in supply; deflationary cryptocurrencies increase in intrinsic value over time as total supply remains constant or decreases.

Key Highlights

  • All cryptocurrencies are either inflationary or deflationary, depending on how their total supply changes over time.
  • Cryptocurrencies with hard supply limits increase in intrinsic value over time and are, therefore, deflationary. Cryptocurrencies with potential unlimited supplies are inherently inflationary.
  • Cryptocurrency function also impacts their inflationary/deflationary status: utility cryptocurrencies are often inflationary, while value cryptocurrencies are frequently deflationary.
  • Transaction costs for creating and exchanging cryptocurrencies have an inverse relationship to a cryptocurrency’s inflationary nature.

Understanding inflation/deflation for cryptocurrencies requires knowing the difference between the intrinsic value of a currency and market value.

1. Deflationary Cryptocurrencies

Bitcoin is the ultimate example of a deflationary cryptocurrency. From the moment of Bitcoin’s creation in early 2009, there was a hard limit of 21 million BTC available for mining. No more BTC will ever exist.

As of late 2022, fewer than 2 million BTC are left for mining. Mining difficulty has increased substantially[1], and as a result, each new BTC is increasingly expensive, making BTC deflationary.

As the overall supply decreases, the intrinsic value of the currency increases, and its purchasing power goes up accordingly. This makes deflationary cryptos good choices for longer-term investing.

Just because BTC has an increasing intrinsic value does not mean that its market value will not decrease. Indeed, there have been several crypto market crashes over the years. But during those crashes, BTC retained total value better than non-value, inflationary cryptocurrencies.

Additional factors contribute to BTC’s deflationary status. The primary factor is that a large portion of the total BTC supply has been lost over time (up to 20%[2], according to some estimates).

2. Inflationary Cryptocurrencies

Bitcoin’s main competitor, Ethereum, is an example of an inflationary cryptocurrency. ETH does not have a maximum supply limit, consistent with the foundational design of Ethereum as a highly transactional cryptocurrency. ETH is intended to be used rather than simply saved.

As of late 2022, ETH supply plateaued at around 120 million.

Ethereum Supply - YCharts
Fig. 1: Ethereum Supply (Source)

As the overall supply increases, the intrinsic value of ETH decreases, meaning it takes more ETH for any given purchase – the classic definition of price inflation. However, one benefit of ETH price inflation is that as prices fall, transaction costs associated with ETH should also fall. Therefore, Ethereum is a better choice for day-to-day currency replacement than long-term investing.

Additional Resources

Article Sources

  1. Minting difficulty
  2. Lost Bitcoin
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