Crypto economics: Understanding inflation and deflation dynamics

Supply and demand are two of the most important components in understanding the economy. They influence everything that holds value in the global market, including commodities like crypto and tokens. Grasping whether an asset is inflationary or deflationary is key to setting expectations for market trends.

Identifying if a certain commodity in the crypto industry is inflationary or deflationary starts with understanding the meaning of these terms. Take note that this concept is not similar to the traditional inflation in terms of economy, which is when prices generally increase on goods and services as the supply decreases while demand stays the same.

Here’s a brief guide to help you learn what they mean, complete with examples to clarify the concepts:

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Inflation: Crypto supplies increase and lose value

Inflation, when it comes to cryptocurrencies, occurs when the supply outgrows the commodity’s demand. The asset’s intrinsic value is lowered when this happens, resulting in financial losses for investors. Therefore, inflationary crypto means that the digital currency tends to keep minting assets which can harm its intrinsic value unless demand can keep up.

Popular examples of inflationary crypto are Ethereum (ETH), Polkadot (DOT), and Dogecoin (DOGE). None of them have any hard limit on supply but they avoid inflation through token burning. A fraction of the assets paid in transaction fees are removed from circulation, limiting the supply to keep it from inflation.

Is inflation bad for crypto?

Generally, yes. Inflation is bad for all commodities as investors were hoping that their assets’ value would go up rather than decline. Crypto developers place counter-inflation measures to protect traders’ interests by keeping the supply scarce. Common ideas put in place include hard capping, token burning, and halving.

The only exception that inflation becomes helpful in the economy is when the investors count on the investment to have a stable market trend. Increasing the supply of assets in circulation means it can keep up with the network’s surge of new users. Inflation helps avoid another Bitcoin situation where the value per asset grows too high to be used in consumer purchases.

How to respond to crypto inflation?

If you’re invested in inflationary crypto, always pay attention to market trends. Signs of inflation in digital assets include increasing supply minted but trade volume remains stable or is dropping. When you notice these signs, consider the following strategies to save yourself from losses:

Diversify your portfolio

Avoid focusing your investments on just one type of crypto. Begin investing in more stable assets. Consider using your inflationary crypto to buy those assets while it holds value. A diverse portfolio gives you plenty of safety nets because they each have individual market trends. The inflation of one crypto won’t affect the others.

Participate in staking or yield farming

Staking is about locking your digital assets in the network to be a stakeholder and earn from fees. Yield farming is where you offer your asset to a decentralised exchange (DEX) and let them loan your funds to other users in exchange for returns. Both strategies create liquidity for the assets that you’re hodling while waiting for a more favourable market trend.

Convert assets to stablecoins

Converting your assets to stablecoins like Tether (USDT) and USD Coin (USDC) is like selling your crypto. These assets are easier to convert to fiat when you need to and it’s safer to hold onto when all other crypto have a bearish trend. Likewise, stablecoins are much easier to use to buy digital assets thanks to wide support from various exchanges.

Deflation: Crypto supplies decrease and create scarcity

Deflation means that the commodity is defined by its scarcity and deflationary cryptos have a hard limit that they cannot exceed regardless of demand. Most of these assets need to be mined to reach their limit like Bitcoin (BTC). Others, like Ripple (XRP), are pre-mined and all of its supply is ready to join the circulation when the demand calls for it.

Examples of popular deflationary crypto include Bitcoin (BTC), Ripple (XRP), and Litecoin (LTC). They all have a hard supply limit that will end the minting of new crypto once reached. BTC and LTC slow down their mining processes after every 210,000 and 840,000 mined blocks (roughly 4 years). XRP is pre-mined so it has already reached its supply limit.

Is deflation bad for crypto?

Deflation is generally bad for most physical commodities because it indicates a downturn in the economy. For crypto, it’s not a complex matter that involves many factors. A scarce supply means that the asset won’t fall to inflation but it also means it can’t meet high demands if its blockchain is too popular. Thus, a deflated crypto can be inaccessible if its price grows too high, resulting in a loss of trade volume.

What to do in response to crypto deflation?

The only sign to watch out for is comparing the circulating supply to the maximum supply. Exchanges track both real-time data, giving you plenty of leeway to respond to them. Consider these strategies when facing deflation in crypto:

Use the asset as a store of value or as collateral for loans

The asset is likely to increase in value but lower trade volume. Hodl this asset to use as a store of value. You may sell it or convert it to other assets in the future for as long as the demand remains high. Demand can stay high if used in institutional trading and collateral for loans on exchanges.

Minimise transactions to avoid costly fees

Higher crypto prices often also increase its network’s gas fees. Thus, transaction fees become increasingly more costly as time goes on. Limit your trade activities in this digital asset to lessen your expenses and focus on strategic transactions.

Consider dollar-cost averaging (DCA)

Dollar-cost averaging or DCA is about steadily buying small amounts of the crypto consistently. This helps you accumulate more of this digital asset over time, building your holdings in assets expected to increase in value. By applying DCA, you can earn more of the asset in a deflationary environment.

What is the better investment: Inflationary or deflationary crypto?

Choosing between inflationary and deflationary crypto depends on what you expect in the blockchain. If you’re looking for a store of value or an asset to bring you profit in spot trading, a deflationary crypto is your best bet. Traders interested in the daily-use cases of the asset as a utility token or for consumer-level transactions are better off looking into inflationary crypto.

There’s not much difference between the two kinds of crypto for short-term investment. The core aspect separating inflationary crypto from deflationary ones is the absence of a hard cap. DOGE, for example, used to have a hard cap of 100 billion but was removed in 2014. This makes the asset change from being a deflationary asset into an inflationary one.

Many businesses have adopted all kinds of digital assets. Sportsbet.io is a good example of accepting various inflationary and deflationary crypto as payment methods. Diversify your portfolio by investing in both kinds of digital assets so you can adapt to the market trends. Sign up at Sportsbet.io to use crypto in bets for a chance to win them back on winning sports predictions.

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