How Do Deflationary Tokenomics Work?

In textbook economics, deflation is generally associated with a contraction in the supply of money leading to the purchasing power of the currency increasing. In crypto, this is essentially the same.

Deflationary tokenomics means that over time, the tokens for the project in question, are removed from the market. This can be done through a variety of different strategies such as token buybacks and token burn on transaction. Token buy backs are done by the company buying back the tokens from the public market and then removing them from circulation. Token burn on transaction is generally integrated into the contract with every transaction having a tax, a percentage of which is burnt. Additionally, projects have a set number of tokens to be created, with the limit never being increased.

This is a huge benefit to individual retail investors, as firstly, it protects them from token inflation. Inflation usually causes a decrease in the purchasing power of a currency as the monetary supply increases. This often plagues fiat currencies, as governments frequently use Quantitative Easing (QE) to stimulate the economy — essentially just printing money! Deflationary tokenomics protects investors from this, as it prevents the market from being flooded with excess tokens as more are minted and sold off by the project developers. The value of the token is thus protected.

Additionally, deflationary tokenomics benefits investors as it often causes the value of the tokens to increase. In the economic model below, the effects of deflationary tokenomics are illustrated in a simplified way with supply and demand curves. The original supply of Token X is represented by S1, and the demand for Token X is represented by D1. As token buy backs/token burns occur, the supply of the tokens decreases, thus shifting S1 to S2. Assuming demand remains the same, the price of the tokens will then increase from P1 to P2, whilst quantity decreases from Q1 to Q2. This benefits the investors as the tokens they are holding will see an increase in value and thus purchasing power (using USD as an index).

There are however several criticisms to deflationary tokenomics. Since investors are incentivised to hoard their tokens, many people worry that these tokens will fall out of circulation. This will create barriers to entry for newcomers, thus making the token itself less valuable. Fortunately, this is not the case for crypto, as tokens are divisible up to millions, if not billions, and do not have the standard drawbacks fiat currencies have. Investors can therefore sell tiny denominations if they wish and keep the market alive.

Summary

Though the concept of deflationary tokenomics sounds complicated at first, they can be easily understood by applying some basic economic theory. Much like any other asset, tokens too, follow the laws of supply and demand.

Deflationary tokenomics benefits investors as it firstly protects them from inflation, whilst increasing the value of the tokens they hold. Though one can criticise the effectiveness of such models, these criticisms are limited in practicality.

Therefore, deflationary cryptocurrencies offer an attractive alternative to fiat currencies as investors are no longer at the mercy of the whims of the government, but rather have an asset which is mathematically coded to have their best interests at heart.

We will never forget you HOGE!

Useful Links

Lupa X Capital

Telegram: https://t.me/lupaxcapitalofficial

Website: https://lupaxcapital.com

Twitter: https://twitter.com/lupaxcapital

Medium: https://medium.com/@lupaxcapital