What is ‘deflationary’ and why is it important for the longevity of a token?
In general, a coin whose total circulating supply is fixed and whose supply is constantly being reduced is said to be a deflationary token.
Today, we will learn what deflation is, and how it relates to inflation, supply, and demand. Also, we will relate what you learn to bitcoin and learn whether it is deflationary or inflationary, and the role of burning for token deflation.
Deflation and Inflation
Inflation is the decline in purchasing power of a given currency over time. As an example, all fiat currencies that are government-issued are inflationary. We can use our current covid situation as an example. Most governments have had to provide a covid relief package to help their citizens, which led to the printing of more bills, leading to an increased rate of inflation. When there is inflation, each unit of currency can buy fewer goods and services. Using the US dollar as an example, what you could buy using 1 dollar 50 years ago, now requires 6–8 dollars to buy the same thing. So if you were to stuff 600 US dollars in a couch 50 years ago you would now only have 100 dollars worth of purchasing power today. Ouch.
Deflationary is the opposite. As time goes on the purchasing power of that currency increases. For a cryptocurrency, this happens because of a decrease in the supply of that token.
Supply and Demand
If demand were constant, a reduction in the supply of a token would lead to an increase in price. However, let's look at different situations with bitcoin and how supply (inflation/deflation) and demand affect the price. When there is a huge demand for a particular cryptocurrency, it means that more investors are buying that coin and this will lead to the price going up.
Is bitcoin inflationary or deflationary? According to its whitepaper, the total supply cannot be more than 21 million bitcoin ever, and more than 18 million are already in circulation.
Every 10 minutes when new blocks are mined, each new block adds 6.25 bitcoins into circulation. This number is held every four years when the halving happens. You can learn more about bitcoin mining here.
In this case, we can say bitcoin is inflationary. However, the demand for bitcoin actually surpasses this inflation, and this is what makes the price of bitcoin go up. So for now, bitcoin is inflationary, however, when all bitcoin are minted it will become deflationary because the total supply can only decrease from there. However, there are already some deflationary mechanisms in place.
Losing private keys
People lose their private keys more often than you imagine. So if you have bitcoin in your wallet and you lose the private keys, unfortunately, you have lost that bitcoin forever. It’s as good as if you have taken that bitcoin out of circulation, and this leads to the deflation of bitcoin.
Let me give you an example:
James Howells, one of the early miners of bitcoin, managed to lose 7,500 BTC. But how did it happen? He had the private keys to his wallets in a hard drive that he mistakenly threw away.
James has been looking for his wallets since 2013, and he actually offered more than 70 million dollars for anybody that can find it. However, it was never found, and that 7500 BTC has been taken out of circulation, achieving deflation.
You can check out this tragic story here.
Token burning
This is the process through which coins are permanently removed from the circulating supply. It is typically performed by the development team. The equivalent in traditional finance would be akin to a stock buyback program. However, not only can a team buy back a token, but they can then burn them which removes them from the supply forever.
It involves parts of the supply that are already available, such as unallocated tokens or those that are stored in the team’s treasury. Some companies burn tokens regularly, while others do so as a one-off event.
But how does token burning work?
Sending the tokens to a “burn address”.
To burn a token, you sent it to an address that no one can access. Since no one has the private key for this address. Once the tokens are sent, the transaction cannot be reversed, and they cannot be withdrawn. An example of a common burn address is Ethereum 0x0, which contains more than $900 million worth of ERC-20 tokens. These types of burn addresses are also often called dead wallets.
There are several reasons for token burning:
- Deflationary purposes
Used to influence the price of a coin. If the supply is reduced and the demand remains the same or increases, the price goes up. However, if the demand decreases, coin burning may not help much, so the team behind the coin has to find ways to always increase the demand for their coin.
- To maintain the price peg of stablecoins
In this situation, coins are burned to keep the price of an asset at a near-constant level. A stablecoin is a class of cryptocurrencies that attempt to offer price stability and are backed by a reserve asset. You can visit this guide to learn more about stablecoins.
- Correction
This enables a project to correct a mistake. For example, Tether created $10 billion dollars in USDT by accident. These tokens had to be burned to prevent the new supply from destabilizing the 1:1 peg with the US dollar.
- To incentivize token holders
As a coin becomes more valuable, holders are incentivized to keep them. To achieve this, Defi projects like KogeFarm burn tokens regularly.
KogeCoin Token
KogeCoin is a deflationary token with a maximum (and total) supply of 50 million.
We launched our token to benefit our users with many utilities, such as staking, governance, dividends, and receiving rewards. One interesting feature about it: all KogeCoin were minted at launch and none will be minted after.
KogeCoin was launched via airdrop to early QuickSwap users providing a one-month window to claim all tokens. Too often, “fair-launched” tokens get sniped by bots who then dump on the rest of us. By only airdropping to active wallets that manually claimed tokens, we were able to avoid a “bot-sniped” launch. The plan was to airdrop out the entire initial supply to any address that claimed their tokens after using QuickSwap (and prove they were real users and not bots). However, around 90% of tokens went unclaimed. Using the DAO our users voted that we distribute the remaining supply as rewards for those staked in our KogeFarm farms. The total supply will be fully distributed in May 2022 and KogeCoin will officially go from being an inflationary token to a deflationary token.
However, that doesn’t mean we don’t already care about inflation. We already have our deflationary mechanism in place and currently use 100% of KogeFarm profits to burn KogeCoin to reduce the supply.
When all KogeCoin are distributed the deflationary mechanism will change slightly. Rather than reducing the supply by burning 100% of KogeFarm profits, we will start providing dividends (in the form of USDC) to KogeCoin stakers. 50% of profits to stakers, 45% of profits to be burned (to reduce supply and increase price), and 5% of profits allocated to developer costs.
In preparation for dividends, we intend to burn as much KogeCoin as possible to significantly increase the value of KogeCoin over time. Starting ~September 2022, we will transition from a 100% burn to 45%. As you can see, we take the burning mechanism very seriously. You can check all about our tokenomics here.
Conclusion
The most well-known benefit of a token being deflationary is an increase in its value. From the community’s angle, a deflationary token, like KogeCoin, is the best way to keep and bring investors for the long run, meaning good and healthy growth for the project itself.
If you have any other questions about tokens and deflation, please stop by the KogeFarm Telegram or Discord communities, where you’ll always find someone willing to help you out.
