Misconceptions and Types of Inflation in Cryptocurrencies

Published by illuminati.e 6 Aug 2019

A cryptocurrencies’ digital nature provides great avenues for experimenting with monetary policies and new ways to manage inflation. They’re definitely poised to replace the 100 year old Keynesian model some economists are safe guarding.

In the Fiat world, sustaining a low inflation rate is one of the key factors to a stable economy. It’s hard to achieve this due to a lack of transparency by central banks who handle the money supply.

In approximately 10 to 20 years, monetary systems will probably reach a point of inflation so high that not using a corporate or national cryptocurrency would lead to the downfall of the economy in that region. Cryptocurrencies backed by blockchain technology would undoubtedly raise transparency when it comes to government spending, reduce illicit drug trade and criminal activity.

So how do cryptocurrencies manage inflation on the blockchain? There are a few ways which include an algorithmic supply model and a community governed supply model.

Algorithmic Supply Model

Never before in the history of money has the level of assurity and certainty been seen in Bitcoin’s monetary policy. BTC has a block halving which occurs every four years which results in the block rewards getting cut in half creating a supply shock as well as an inflation reduction. Inflation of Bitcoin is at 3.87% at the time of writing this article and the entire supply is set to hit the max cap of 21 million in the year 2140.

With a fixed supply of 21 million BTC, we can know for sure what Bitcoin’s supply will be in the future. When comparing these features with traditional money, we know for a fact that the future supply is totally unpredictable and directly influenced by political and economic situations.

It’s also known that these numbers associated with Bitcoin are not subject to change because of the math and cryptography in Bitcoin’s core code and sound governance.

The above image shows us the decreasing supply and inflation over the next decades to come.

Community Governed Supply Model

The most known example of community governed supply is EOS. Over 34 million EOS which was worth 167 millions dollars was removed from circulation permanently. On May 8th, 2019, 15 out of the 21 block producers agreed to vote on burning 34 million EOS which was left idle in a savings account.

The EOS blockchain has a 5% annual inflation rate. 4% goes to a worker proposal fund which gets to be used collectively as a community and the other 1% goes to the Block Producers. The worker proposal fund was created when the mainnet launched in June 2018. This account was sitting idle for many months accumulating funds and many in the community believed that it was a honey pot which could result in an attack vector on the entire network let alone the unnecessary inflation needed.

The entire EOS community wanted to burn the tokens that were not being used and the block producers acted on behalf of the community by performing the actions needed. This however, does not affect the burning of future contributions to the account and the inflation will continue into that account until EOSIO 1.8 upgrade takes place in 1.5 months.

Because of the law of supply and demand, each token now represents a higher proportion of the network value.

You can have a look at the transaction below or in the block explorer here which shows us proof of the token burn taking place.

To sum things up, inflation should not be looked down upon. A Lot of people correlate the word inflation with negativity. It can be negative or positive depending on a number of factors.

New, innovative business models have risen with the help of blockchain tech. Inflation helps to fund these ecosystems and for some projects, they are essential. It’s a better way to structure things. Take EOS for example with an annual 1% inflation but for users it’s absolutely free to use unlike Ethereum where transaction fees need to be paid for every little action.

By having a small percentage of inflation which can be allocated to pools and have those pools allocate to people for rewards or marketing etc., the ability to continually have new funds created is easier for these ecosystems.

In a way it is a burden the ecosystem takes on but it’s no different than any country in the world today or a business taking loans, debt, raising money etc. except with cryptocurrencies and tokens we have a much better way of doing that because rules can be publicly programmed and transparent so people can see what the rules are.

Let’s say hypothetically in the United States there’s a scheduled amount of inflation every year that’s supposed to be made but actually there’s nobody enforcing that its stuck to and that is what is problematic in this scenario. The accountability is doubtful and suppose you wake up in the morning and the country decides to print 5% more inflation of the currency resulting in more inflation for that year. Its damaging buying power over the years and generations to come.

Inflation in cryptocurrencies can be both a good thing as well as a bad thing. Regular checks and balances offsetting inflation can work wonders and ignoring it could prove to be detrimental for the token or project.

It’ll be exciting to see the monetary models in cryptocurrencies in the future. Will flexibility be favoured over certainty? How will the different types of supply models affect liquidity of these tokens? One thing is for sure. The future looks bright for crypto.

And as always, stay safe and don’t get rekt.

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DISCLAIMER: This is not to be taken as financial advice. My views in this article are personal opinions based on my research and should not be considered as financial advice. Always do your own research.

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