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The speculation surrounding deflationary cryptocurrencies

Cryptocurrencies are notoriously volatile, making price predictions particularly challenging. Market analysts appear divided about where the market is headed after an up-and-down few months. Some believe we are in a cooling-off period in which the price is likely to decline to yearly low levels, while others suggest the price will rise to new records by the end of 2021. In this article, we will examine an element of deflation that experts and analysts have discussed in light of global economic circumstances.

What is meant by Deflation?

Deflation is typically associated with a reduction of monetary supply in macroeconomic terms. A variety of factors can contribute to a decrease in prices, including deteriorating economic conditions, advances in technology, or simply lower demand.

The concept of deflationary cryptocurrency refers to cryptocurrencies with a rapidly dwindling supply of coins. Simply put, coins become more valuable as the number of coins in circulation decreases.

Cryptocurrencies with deflationary characteristics often have a fixed, unchangeable maximum supply cap in their code. On the other hand, inflationary cryptocurrency tends to feature high supply cap levels or to have no supply caps. The inflationary aspect of cryptocurrencies is similar to non-traditional fiat money, where the value of a currency decreases as banks (or a block) mint new coins, with a limitless supply.

The high burn rates of some cryptocurrencies, in addition to the hard caps, make them deflationary. There are several ways to burn a cryptocurrency.

A flat burn rate is used by some currencies and tokens, with a certain percentage of each transaction being destroyed. Some blockchain foundations or organizations may also implement buyback programs. In this case, it buys a considerable amount of cryptocurrency and then sends it to a dead wallet, removing it from circulation.

Difference between deflation and inflation

With a central bank’s ability to create money at any time and without limit, the dollar or euro’s value will decrease over time since a central bank can create money at any time. According to the U.S. Census Bureau, a loaf of bread cost $0.09 in 1930, $0.36 in 1970, and $1.98 in 2014. The cost of baking bread has not gone up. In essence, the dollar is less valuable now than it used to be.

With the printing of more money by central banks, fiat currencies become less valuable as they become less uncommon. It is called inflation when the amount of money goes up (and the value of the currency goes down). Inflationary models are fundamental to all major fiat currencies today, and they serve as the basis for all economic assumptions.

Unlike national banks that issue money and set monetary policies, Bitcoin has no central bank. As soon as it reaches 21 million coins, there’s an algorithm that stops. Once this happens, a lost BTC is permanently removed from the money supply, and so there will be a deflation of the money supply over time. Consequently, bitcoins will become rarer and more valuable as a result.

Inflation Vs Deflation

Bitcoin is deflationary?

The answer varies depending on how you define deflationary digital currencies.

For a currency to qualify as a deflationary currency, its supply must decrease. In total, Bitcoin mining adds 900 BTC per day or 6.25 BTC after every block.

Eventually, this will change. In total, 21 million Bitcoins are available, of which 18,783,668 are currently in circulation. Approximately 2140 will be the year a miner will mine the final block of bitcoin. After that, no more bitcoins will be created. Is this a sign that bitcoin will become deflationary? I don’t think so.

It is estimated that several bitcoin holders will lose their coins each year. If someone loses the password to their crypto wallet, burns their bitcoins, sends bitcoins to the wrong address, or forgets about them, they might suffer from this loss. Bitcoin could become deflationary by 2036 if holders lose 0.5% of their BTC every year, according to one of the leading wallet manufacturers. This could happen in 2048 if this number was 0.05%.

Ethereum is deflationary?

There is no evidence that Ethereum is deflationary at the moment, although some analysts believe this may soon change. There was little discussion of Ethereum as a deflationary currency before the London Hard Fork and the launch of EIP-1559. Due to the upgrade, however, the network was required to burn a base fee after each transaction.

The deflationary blocks burn more ETH than they reward since they burn more than they reward. ETH must have a consistent amount of deflationary blocks if it is to be deflationary.

Deflationary blocks have been passing through the Ethereum network hundreds of times in the past week — though this is a tiny fraction compared to inflationary blocks. During one hour on August 11, the ETH Burn Bot recorded a -3.12% annual deflation rate, but every block since has been inflationary.

Moreover, as Ethereum developers are planning for the future, they will do away with mining entirely and switch to a more energy-efficient Proof-of-Stake (PoS) algorithm that consumes a fraction of the electricity of mining and doesn’t have to be upgraded frequently.

In addition to being cheaper, the PoS process will allow for the issuance of new coins to be reduced significantly while still subsidizing network maintenance, which is why many anticipate Ethereum to become deflationary after switching to PoS. It is estimated that the change will take place sometime in Q1 2023, although no date has been set.

Important Fact

As we speak, inflation is taking over fiat currency. Deflation occurs when the purchasing power of the currency is decreased — the demand for goods and services outweighs the supply and production declines. We believe that in the long run, the asset will become more valuable. Our view on Deflation vs Inflation on ETH and BTC is that ETH’s burning mechanism (EIP 1559) and the continuously growing demand for it will lead to deflation, which means that ETH’s price will rise. The supply of BTC will be reduced by 50% every four years due to the halving mechanism. As a result of this and the growing demand for BTC, the value will increase.

Final comments

The concept of deflationary currencies is very unusual in economic history. Cryptocurrencies are probably the first to use this strategy. The deflationary aspect of crypto has attracted economists’ attention. Precisely for this reason, and some believe it is going to change our views on money forever. The deflationary currency system, however, is viewed by some as a factor that will result in hoarding and liquidity problems.

In combination with the decentralization and lower emission rates, the burn feature makes cryptocurrencies more suitable for the masses compared to just corporate. Bitcoin and other cryptocurrencies are seen as a viable solution to deflation because they remain unaffected by global deflation as well as offering a real alternative to the current bubble.

Furthermore, some argue that the problem lies not with crypto’s deflationary nature, but with fiat’s inflationary nature.

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