Crypto Inflation: Everything to Know
By Beluga Research July 20, 2023
- Crypto inflation refers to the increase in the supply of a cryptocurrency over time
- It is a deliberate mechanism implemented in some cryptocurrencies
- This incentivizes participation, reward network validators and maintains a blockchain's operations
- Inflation in crypto can be achieved through different methods, such as proof-of-stake (PoS) or proof-of-work (PoW) consensus algorithms
Crypto inflation refers to the increase in the supply of a cryptocurrency over time and is mostly determined by how frequently a network adds new coins of the same type. This causes an inflation in value of a cryptocurrency and guards against a network processing too few transactions and being unsecured. It is not measured by the Consumer Price Index (CPI), which tracks the price of a basket of goods and services.
A Brief History
In 2009, a party or group of parties with the pseudonym Satoshi Nakamoto created Bitcoin, the first cryptocurrency. Bitcoin creates new coins every time a block of transactions is added to the blockchain. The rate at which new coins are created is halved every four years. The total maximum supply of bitcoin is capped at 21 million coins. As a result, Bitcoin's inflation rate decreases over time. Bitcoin's inflation rate will reach zero when all 21 million coins have been mined.
Several later-created cryptocurrencies, including litecoin and dogecoin, also have fixed inflation rates. Yet other cryptocurrencies, like ether, have a variable inflation rate determined by the network's consensus algorithm. The rate at which new coins are created can change depending on the network's needs.
What is Crypto Inflation?
Crypto inflation is the rate at which new coins are created in a cryptocurrency's network. This rate is usually fixed and is determined by the cryptocurrency's protocol. The idea behind crypto inflation is to incentivize miners to validate transactions and secure the network. This means that the supply of the cryptocurrency increases over time. That phenomenon leads to inflation.
The impact of crypto inflation on the market depends on the cryptocurrency's supply and demand dynamics. If the demand for the cryptocurrency increases faster than the supply, the price of the cryptocurrency will increase. If the supply of the cryptocurrency increases faster than the demand, the price of the cryptocurrency will decrease. This is why some cryptocurrencies, such as bitcoin, have a fixed maximum supply to prevent excessive inflation.
Crypto inflation can also have an impact on the cryptocurrency's use case. If a cryptocurrency's inflation rate is too high, it may not be a good store of value. This is because the cryptocurrency's purchasing power will decrease over time. If a cryptocurrency's inflation rate is too low, it may not be a good medium of exchange. Its supply is unlikely to be able to keep up with the demand.
- Recognize and understand the risk of crypto inflation. An investor should research how crypto inflation will affect their asset before a purchase or trade.
- Contribute to the community's decisions about crypto inflation. Investors who hold a native coin of a certain type of cryptocurrency can share views on what the community should do to encourage or discourage crypto inflation.
- Compare crypto inflation to the inflation of fiat currencies. An investor will be able to detect differences between inflation and how crypto inflation can influence the cryptocurrency ecosystem.
- Crypto inflation is primarily caused by the creation of new units. Fiat, or traditional, currencies usually incur inflation when the government's central bank prints more currency. In contrast, cryptocurrencies usually have a predetermined supply schedule.
- Each cryptocurrency has its own schedule. Litecoin, a cryptocurrency that was created as a faster and more efficient version of bitcoin, has a maximum supply of 84 million coins. This is four times that of Bitcoin. Litecoin's supply is programmed to decrease over time. Block rewards halve every 840,000 blocks, or roughly every four years.
- Influenced by other factors. Crypto inflation can be influenced by network usage and adoption. If a cryptocurrency becomes more widely used and adopted, the demand for the currency may increase, driving up its price. This can lead to an increase in mining activity. That can increase the rate of new coin creation, resulting in inflation.
- Crypto inflation can be a positive force. This can help incentivize network participation and mining. Such activities help secure the network and increase its overall value.
- Predictable supply. Cryptocurrencies have a predetermined supply limit. This means that the rate of inflation is predictable. This predictability makes it easier for investors to plan their investments and make informed decisions about the future value of a cryptocurrency.
- Fixed supply. Cryptocurrencies have a fixed supply. They are not subject to inflation caused by an increase in the money supply. This feature makes cryptocurrencies an attractive investment option for parties concerned about inflation.
- Inflation control. Inflation in cryptocurrencies is controlled by a set of predetermined rules. These are programmed into the cryptocurrency's code. The control ensures that the rate of inflation remains stable and does not fluctuate with changes in the market.
- Decentralization. The decentralized nature of cryptocurrencies means that they are not subject to the control of any central authority, like a government or a central bank. This feature makes cryptocurrencies immune to the inflationary policies of central authorities.
- Volatility. The value of crypto can fluctuate rapidly and unpredictably. This volatility makes it difficult for investors to predict the value of a cryptocurrency. Unpredictability can lead to significant losses.
- Limited acceptance. Cryptocurrencies are not widely accepted as a form of payment. This limits their usefulness. Limited acceptance can make it difficult for investors to realize the full value of their investments.
- Lack of regulation. There is no oversight to ensure that the rate of inflation remains stable. This lack of regulation can lead to uncontrolled inflation and a loss of value in the cryptocurrency.
- Security concerns. Cryptocurrencies are vulnerable to security breaches. These can incur the loss of coins and a decrease in the value of the cryptocurrency. Hackers can exploit vulnerabilities in the cryptocurrency's code to steal coins. There is no way to recover lost or stolen coins.