What is Inflation in Cryptocurrency World?

Imagine yourself as a citizen of an economically unstable country for a more everyday example. A Nestle chocolate you loved very much as a kid and bought very cheaply is not that cheap anymore as you approach your 30s. This is what inflation is in its basic means. A currency depreciates over time, causing prices of consumer goods within the country to rise.

• Inflation can be defined as an economic process where any currency such as the Ruble, Bitcoin, EU, or US Dollar decrease in purchasing power over time due to various reasons.
• Inflation can be caused by demand, cost, and currency imbalances.
• Inflation in the cryptocurrency world is generally caused by an unlimited circulation supply or unplanned initial distribution of tokens.
• There are certain strategies used by the crypto projects to prevent inflation, such as limited supply, token distribution plan, and proof-of-burn (PoB).

The Causes of Inflation

One of the most common causes of inflation is an increase in the circulating money supply. As another general cause of inflation, a decrease in the supply of a particular good in high demand may result in inflation.

BONUS: What reminds you when you read ”circulating money supply causing inflation”? Consider tokens that offer staking services to users and are designated to have an unlimited supply number for rewards. They constantly issue tokens in the ecosystem. This increases the number of circulating tokens and causes the value of the tokens held by the stakers to decrease or to be steady for a really long period of time. One of the tokens that experience this problem is CAKE.

Another example: Although some tokens are not determined to have an unlimited supply at the beginning of any crypto project, the very high number of releases and distribution to the project team or those who are excited about the project for marketing purposes can cause circulating supply more than necessary.

There is no single theory like “2+2=4” as to why inflation occurs in the world in general, but there are several widely used approaches.

Demand Inflation

Inflation occurs as a result of the increase in demand for goods and services. In other words, if demand is growing faster than supply, prices will inevitably increase. In short, it is a  “too little goods, too much money” situation.

Cost Inflation

In a scenario where production costs increase, in order to make a profit, each company naturally needs to increase prices so that it can keep the profit margin stable. However, the result of rising costs may create a domino effect, leading to the price of other services in the economy to rise as well.

Currency Inflation

If there is too much supply for something in the economy, the price of that thing will inevitably fall. Currency inflation is the currency version of the supply. Too much money will lower the currency’s value; the result is that the price of everything goes up.

The Inflation in Cryptocurrency World

Let’s get straight to the point. Do cryptocurrencies experience inflation? Yup. But is this inflation as serious or unpredictable as normal currencies? No. However, to better understand the relationship between the crypto world and inflation, we need to take a little time-travel on Bitcoin’s history.

About a decade and a half ago, Bitcoin was worth almost cents when the first Bitcoin award was given. However, over time, Bitcoin reached the limit of $ 70,000, with a beginning of ten dollars, then a hundred dollars, then a thousand dollars. Although the coin market is volatile and has experienced a lot of ups and downs, Bitcoin, when you look at it on a large scale, has always been on an uptrend. In contrast, many national currencies have experienced a depreciation trend. Thus, this attribute of Bitcoin has made it a great investment tool in the eyes of investors. This is because people have become less affected by inflation when they invest their assets in Bitcoin while their national currency decrease in value.

Bitcoin: Resistance to the Inflation with ”Limiting the Supply to 21 Million”

Because inflation poses a continuous threat to the value kept in fiat money, investors naturally tend to store money by investing in assets that have a stable value although years pass by. For example, throughout history, gold has long been the first one coming to mind to be used as a protection against inflation. However, it seems like the tide has turned in the cryptocurrencys’ favor, as people slightly begin to stop investing in gold.

So, why is that? Why is Bitcoin resilient to inflation? The main reason is Bitcoin’s design includes a limited supply, and It is known when the last Bitcoin will be mined since there will not be more than 1 Bitcoin out of 21 million. Therefore, everyone knows and can predict the future of Bitcoin, which makes it resistant to inflation.

Dealing with Inflation in Crypto World

Commodities such as gold and silver can be a safe haven preferred by investors during periods of high inflation in fiat currencies. In the last few years, wars, economic problems, and COVID-19 caused loss of trust in traditional marketplaces and concludes in investors considering cryptocurrencies as an option. However, the volatile nature of cryptocurrencies, which makes daily value changes of 30-35% even a routine, still raises concerns.

Stable Coins

This is exactly what led to the development of stable coins. Stable coins, whose value is fixed at a ratio of 1:1 to a secure fiat currency or commodity such as USD, are offered as a much safer haven in the bustling crypto market. Stable coins can be a good option for daily trading when inflation is very high. Especially during periods of hyperinflation, there can be quite a lot of investors returning to stable coins in the crypto money market in order to protect the value of the money in the hands of the consumer.

Proof of Burn (PoB)

Unlike Bitcoin, Ethereum is a cryptocurrency based on unlimited supply. In other words, there is no limit to the number of Ethereums that can be produced for circulation.
Here are a few factors that make Ethereum vulnerable to inflation:

• With Ethereum mining, users can generate unlimited Ether.
• The block creation speed on the Ethereum network is quite high, even a block can be created in just ten seconds.
• Since mining is free and profitable, there are millions of users who want to participate in the Ether generation process.

When all these factors are combined, it is possible to say that as the supply increases, the demand rate for Ether will decrease and the value of Ether in circulation will decrease. Recently, when the value of Ether fell below 2000 marks, a significant amount of Ether was sent to digital wallets that no one could access using the proof-of-burn method. In other words, Ethers were burned. This led to a certain improvement in the supply-demand balance in the market.
Of course, PoB doesn’t always produce great results. But when done at the right time and at the right rate, it is a good method to combat inflation.

Roadmap for Token Distribution

In some crypto projects, although the entire supply is ready, not all of them are put into circulation in order to avoid inflation and pressure on the price. HBAR, the native coin of the Hedera blockchain network, is a good example.
In the roadmap announced in the project, a certain amount of coins can be reserved for future staking services and can be held before they are released. At the same time, it may be possible to keep the coin out of circulation at a certain rate in order to distribute it with airdrop in the future or to be used as a fund in various projects. All distribution plans of this type are to prevent unexpected inflation problems.

Dealing with Inflation in Traditional Finance

Unplanned inflations can cause serious damage to the economy in the short and long term, and therefore, they need a remedy as soon as possible. In such a scenario, governments are to review monetary and fiscal policies and make adjustments to reduce the effects of inflation.

The two most popular methods of fighting inflation included within these adjustments are quantitative easing (Q.E.) and quantitative tightening (Q.T.), applied by central banks. In Q.E., a central bank purchases bank assets to aid the economy through newly-printed money. On the other hand, Q.T. involves diminishing the money supply to reduce inflation.

Besides, sometimes governments can raise interest rates drastically to deal with inflation. Since raised interest rates make it harder to borrow money due to expensiveness, credit becomes less optional among both the public and investors. However, due to this practice, the country’s economic growth may slow down, as people will stay away from investing by taking out loans.

Advantages and Disadvantages of Inflation in Crypto

At first, inflation may seem like a monster to be beaten down. However, there may be situations where even inflation is advantageous.

The Best Cryptocurrencies to Hedge Against Inflation

Are you looking for suitable cryptocurrencies to protect your assets and investment process from inflation? We can list the coins that offer a relatively safe space to investors with their limited supply and strong adoption features as follows:

1. Bitcoin (BTC)
2. Ethereum (ETH)
3. Binance Coin (BNB)
4. EOS (EOS)
5. Secret (SCRT)
6. Curve DAO Token (CRV)
7. ThorCHAIN (RUNE)
8. NEAR Protocol (NEAR)
9. Harmony (ONE)