Inflationary vs Deflationary: Why it Matters?
Inflation has been a concept that has existed in every part of our lives and its impact has been felt since the very beginning of our financial system. Inflation represents a lifelong relationship between demand and supply of goods/services but its implication in the general economy has been complex for everybody. So what is the Inflation and Inflationary concept? Why does it matter more than you think?
Inflationary vs Deflationary
Inflation is a concept that has a strong impact on our economy so much so that our recent interest rate hike was the result of high inflations but to know its strong relations, we need to dive back to the beginning of our financial system. Our modern financial system originated from a concept called Barter in which to obtain goods/services which we want, we need to trade it with something we currently have.
At that moment the concept of trade was born but inflation still didn’t exist as there was no general perceived value yet that could be applied to everybody. Through countless years of barter, we know that every good/service is valued differently by everyone as an apple will not be worth the same value as a fish and this is where our monetary system which is to help facilitate an easier trade process by assigning a value for every good/service available.
This value will vary according to the Supply of the Goods/Services that are available and the amount of demand that is there in the market so only the right people can obtain them. Of course, this wouldn’t be a problem as back then the amount of money supply was fixed by the Gold Standard so there would always be more goods/ services available than the amount of demand, and value remained stable. This was not the case as told by the history of a lot of countries expanding their money supply and, in turn, making their currency worthless.
The value of a currency is defined by how much goods/services it can afford and the value of goods/services is defined by how much people are willing to pay for it. Through these two concepts, we can summarize that inflation is caused by the disharmony between these two. Now as the trade has to be performed for us to get what we need, an alteration on the price has to be made so that the trade process is completed.
Inflation is an important part of our economics as it generally means that the economy is prospering in the right direction but it’s not always good news. Inflation below 5% per year is tolerable for the economy but when the inflation reaches the hyperinflation stage, it usually risks destabilizing the economy and even causes a crisis as the currency becomes worthless. One of the most recent examples of this is what happened in Venezuela as prices of goods/services reached more than 10,000,000% inflation rate by the end of 2019 due to excessive expansion of the money supply.
How does all this relate to DeFI space? We need to understand all this because of what Bitcoin was created for. It was meant to be an alternative currency that is backed up by Blockchain. Bitcoin had a limited amount of supply 21 Million to protect its value in the long term. This is also why at the peak of its value, it was able to reach an all-time high of $70,000 because nobody could ever increase the supply of Bitcoin so in the long term, it should become more valuable.
With this feature of limited supply, Bitcoin can be fairly considered to be a Deflationary Digital Asset as its supply deflates over time. Deflationary Digital Assets use various mechanisms to reduce their limited supply such as the Burning process or transaction fees. Deflationary Digital Assets also have a predetermined deflation rate coded in the protocol. This rate determines the percentage decrease in the currency’s total supply over time. For Instance, Bitcoin’s halving mechanism reduces the amount of reward received by miners to 50% every couple of years.
On the other side of the concept, there is also the Inflationary Digital Asset which does not have a limited supply and it increases over time. Inflationary Digital Asset uses a combination of predetermined inflation rates, supply constraints, and mechanisms for distributing tokens to maintain the supply in the network. For instance, Block and Staking reward that is earned by validating transactions on the Blockchain Network.
These two concepts have different kinds of benefits and disadvantages that carry with their predetermined features. Inflationary Digital Assets are designed on expanding their supply to incentivize participation in the network while Deflationary Digital Assets are designed to make each of the coins more valuable by making it scarce in the long term. This is why the market is mixed on this concept with a fair share of projects adopting each concept to its success.
Both concepts have also sparked a lot of debates as Inflationary and deflationary cryptocurrencies mainly differ in their monetary mechanisms and supply dynamics. These distinctions are what will cause significant implications for each digital asset and the DeFI space as a whole. The success or failure of each concept will depend on how it is tuned to the business concept but what are its general implications?
Why does it matter?
Inflationary vs Deflationary matters so much to the stakeholders within the space because of the idealism that Digital Currency represents. Bitcoin was introduced in 2008 as a hopeful aid towards the Crash of the Housing Market. It represented a currency that was limited in its supply so it could be a proper store of value over the long term, something that was originally missing from our fiat currency with its ever-expanding supply.
An also important point that favors Deflationary Digital Asset is that its limited supply resembles much of the commodity which has been highly valuable due to its scarcity and it incentivizes users to hold their digital asset rather than to trade it. Gold for instance is an asset that has been valuable for thousands of years due to its limited supply and has been a comparative figure towards Bitcoin.
On the other side Inflationary Digital Asset also matters because of its high participation as two of the largest networks in the DeFI space, Ethereum and Binance, adopt this method. It is proof that the activity in both of these networks encompasses almost 60% of the DeFI space with 80% of Dapps and DEX built on this network.
In the end, the debate about Inflationary vs Deflationary will be a never-ending discussion. However, it is important to define the long-term plan for the DeFI space. Does this Digital Asset such as Bitcoin, Ethereum, and other acts as a payment method or an investment option? If it does act as a payment method then the traditional economy has taught us not to expand its supply too far as it might cause a liquidity crunch which is what happened with FTX and Terra Luna. If it does act as an asset class, then everyone must be willing to hold them and participate in the long-term success of the network because if the network succeeds, the token/coin also will be valuable.
Every Digital Asset needs to always put its supply in check so there is always more demand for it but also does not deter anybody from owning them and this solution lies in a mix of both of these systems. It should always be scarce enough for people to understand their value while continuously providing benefits to incentivize users to keep on collecting and holding them and if there is a digital asset that possesses this quality, it will set itself up for success in the years to come.
We at Nagaya Technologies realize the benefits provided by these two concepts and managed to develop them into one hybrid concept. Nagaya is the world’s first hybrid digital asset that is limited in supply to maintain its store of value while providing benefits from its subsidiary projects to encourage more holders to keep collecting this Digital Asset in the future. For more information regarding the latest updates on Nagaya and our whitepaper, you can visit us at https://www.nagaya.co
Or you can talk to us at t.me/nagayaofficial
