Inflation vs Deflation When it comes to tokenomics inflati | Trader X - Official Channel

Inflation vs Deflation

When it comes to tokenomics inflation/deflation mechanisms and total supply are something to watch for. Considering fiat, Inflation is the reason why your grandmother paid less for a dozen eggs than you do (printing too much money does the job).

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Nevertheless, this is not something seen in cryptocurrencies. There is a capping limit of tokens that ever to be created (max supply). Inflationary uncapped cryptos, just like your Dogecoin, without max supply will continue “printing” their coins until the end of time, just like fiat currencies. In this case, you might find your tokens suddenly losing value as additional coins start to flood the market.

However, an inflation is not necessarily an issue, as long as it's low (just in the case of Ethereum where it’s inflation rate is getting lower over the years), and as long as you aren't planning on waiting to sell when you retire.

It is also important to mention that inflation is used by many projects to incentivize network participation. In general, inflation is used by Proof of Stake cryptos to incentivize validators and delegators on their network. Inflation is also used to reward liquidity providers and yield farmers with DeFi tokens.

However, the sort of aggressive token inflation that is used to pay liquidity providers in many Defi protocols will probably cause several issues in the first place. With these tokens, it is best to follow the wise words of finance's creator: “do not buy it, earn it”.

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On the other side of the fence, so as to battle the inflation problem that wrecks fiat as well, the implementation of deflationary models is vital. Inducing scarcity through burning or reducing of the rate of produced coins, is helpful driving up the value of the token assuming that demand stays constant.

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Therefore, even if in the case that the demand on Bitcoin does not increase (quite unlikely for the digital gold), the price eventually will go up as the supply continues to decrease. And even worse, how many private keys have become unrecoverable? Therefore, how many people are encouraged to hold their BTC ?

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Now, let’s play the devil’s advocate. In the case of a continuously limited production of coins, users are encouraged to hoard coins, not spend them. Wait a minute, is it really a currency or a commodity? When we are talking about Bitcoin as a payment asset, yes, it is somewhat a problem.

But the real problem does not lie here. In Proof of Work cryptocurrencies, such as Bitcoin, miners are paid through the inflation process of mining. However, BTC rewards decrease over time, so miners will be less encouraged to participate as the rewards will consist entirely of transaction fees, making mining unsustainable. In the worst case, the situation of Tragedy of Commons emerges, where miners are acting on their economic interest, in a way that does not benefit the network