In the world of cryptocurrencies, there is an underlying battle between inflation and deflation. If a cryptocurrency is experiencing deflation, the currency enters periods of economic growth, which in turn causes the asset to grow in value. But if a cryptocurrency is experiencing inflation, the opposite happens. As the cryptocurrency’s price grows, the cost of mining increases, and the currency becomes less effective as an investment. Unknowingly, cryptocurrency investors often fall victim to inflation or deflation. In this article, we will explore the cause and effect of each and how they relate to one another. We’ll also take a look at how they are playing out in prominent cryptocurrencies today, as well as what that means for investors like you.
Deflation vs Inflation
When comparing crypto deflation vs inflation, the difference is that inflation is a measure of production while deflation is a measure of supply. The most practical way to see the effects of inflation is through Bitcoin and its mining function. With each new block mined, a fixed amount of Bitcoin will be created, which amounts to an increase in the coin’s supply over time. An increase in supply causes prices to fall as demand falls in relation to supply. Conversely, when supply decreases, the price can increase by virtue of the lowered demand.
What is Crypto Inflation?
Cryptocurrency inflation is a monetary policy implemented by the cryptocurrency’s developers and is designed to keep the currency stable. Cryptocurrencies that inflate do so by creating new coins to increase the supply of their currency. This can be done by increasing the number of coins produced over time or through a “hard fork.” This changes the code that hard-forks away some or all of the old currencies and creates an entirely new blockchain.
What causes Crypto Inflation?
The only way to create new money in a crypto economy is through mining, and we can see that the increased complexity of mining causes crypto inflation. The higher the difficulty of mining, the more hash power you need. The more hash power you need, the more money it costs to mine. This increase in cost causes miners to sell portions of their profits to pay for electricity and hardware maintenance. As a result, some coins are sold on exchanges for fiat currency or other cryptocurrencies. This creates a supply and demand issue within the crypto economy that requires companies to adjust to prevent the price from plummeting.
What are the effects of Crypto Inflation?
As the price of a currency increases, the conversion between a cryptocurrency and fiat also increases. This is because cryptocurrencies with high inflation rates are usually not practical for use as a transactional currency. The increased cost of goods and services in relation to the declining value of your coin eventually makes an inflationary cryptocurrency impractical. Some investors choose to hold onto their coins, hoping that they will continue to rise in value.
However, this can be an ineffective strategy. In the case of Bitcoin, inflation is estimated to decrease by 0.3% per year. This estimation is based on the assumption that all coins will be mined by 2140. While this may seem like a long way off, the network has seen quite a few changes since Bitcoin’s inception in 2009, including how long it takes to mine new blocks. There will be a time when the block reward, which currently sits at 12.5 Bitcoins per block mined, will drop to 6.25 coins.
There are also many different estimates for how long it will take before all of the coins are mined, giving investors and miners a wide range of figures to choose from when making their investment and planning strategies. This can make it challenging to predict Bitcoin’s inflation rate and whether it will continue to decrease as the network grows and expands.
Read Also: Different Types of Cryptocurrencies
What is Crypto Deflation?
Cryptocurrency deflation is a monetary policy that is used in tandem with an inflationary policy to prevent the effects of excess currency from entering the economy. Deflation can be achieved by either increasing the time it takes for new coins to enter circulation or decreasing the block reward over time. The goal of both strategies is to reduce the amount of currency in circulation, thereby increasing its value.
What causes Crypto Deflation?
In an environment where the price of a cryptocurrency is decreasing, miners will spend less money on hardware and electricity to mine the currency. This means that fewer coins will be generated, and a smaller portion of the block reward will go towards paying for electricity, hardware, and maintenance. The reduced available supply will make the cryptocurrency more valuable compared to fiat currencies and other cryptocurrencies with high inflation rates. This reduces the supply of currencies in circulation, increasing their value.
What are the effects of Crypto Deflation?
Once a currency is no longer producing coins, deflation will eventually cause the price of that asset to decrease. This is another reason why some investors choose to hold onto their crypto rather than sell it for fiat. The goal with cryptocurrency is to hold your coins so that they gain value over time. If you choose to sell your coins, you risk losing money by investing in a currency where the price is decreasing. To make this strategy sound more viable, it is recommended to only sell when the price of your coins is decreasing faster than the price of other cryptocurrencies.
With that said, deflation is not always a good thing. In the case of Bitcoin, for example, it is unlikely that the value of a Bitcoin will continue to increase as long as the supply of new Bitcoins is decreasing over time. This means that if the network were to eventually reach a point where new coins are no longer created, investors would be at risk of losing money on their investment. The majority of other cryptocurrencies follow a similar path towards inflation or deflation.