Introduction
When we study economics, inflation and deflation are two terms that are bound to feature our reading. Supply and demands chains influence the prices of commodities in real world. No matter how overvalued a thing is, if its demand dwindles, the price loses its footing and deflation sets in. In contrast, when supply shrinks and the demand skyrockets, or even if it stays at the same level, prices get out of control, and inflation sets in. These two terms carry substantial significance in fiat economy as well as in blockchain networks and cryptocurrencies.
Triggers of Inflation
As with any other occurrence in economics, there is no single particular factor that kick starts inflation. Had it been so, countries would have easily avoided its recurrence. In traditional syllabus books, it was taught that inflation is the direct cause of over-printing money. This was said to happen because a state was authorized to print only the amount of money that was backed by gold reserves. However, the gold standard had started being overlooked about a hundred years ago and was officially discarded in 1973.
Simply put, the single most important factor of all the contributing causes is the reduced supply of goods or increased demand by users. Besides, expansionary monetary policy can help grow inflation. Such policies encourage money printing, so it is also called quantitative easing. Since prices keep rising during inflation, people usually spend more in fear of buying at even higher prices in future. This buying spree raises demand and increases the prices further. Weak currency exchange rates can cost a country loads of money when importing essential items.
Effects of Inflation
Its most harmful impact is the reduced purchasing power of people because price hike makes them pay more for the same quantity of goods. Elevated cost of living dents their savings and the standard of life declines. Prices of services also increase because workers need more to cope with dearness. Investors are attracted towards risk-off assets like real estate and gold. This takes the toll on businesses and jobs, so unemployment rises. Borrowers benefit from inflation as they will be paying back the money that has less value than that they borrowed and spent.
What Causes Deflation
After having studied the causes of inflation, it is easy to infer what engenders deflation. It is obviously the exact opposite of inflation. When the currency of a country gets stronger, it has to spend less on imports, and more and more money ends up in the national exchequer. Prices also plummet domestically, and people feel no urgency to buy. The demand of goods goes into downtrend, increasing the supply and pushing the prices down further. Finally quantitative tightening, or restricted printing of money can also result in deflation.
Impacts of Deflation
Where inflation reduces people’s purchasing power, deflation improves it. But people tend to buy less as they expect the prices to fall further. Less demand turns the available supply superfluous, and business and factories suffer. Layoffs ensue as a result of reduced profits. Borrowers are in hot water as they have to pay with overvalued money. In short, deflation may seem attractive at first glance but in the long run, it may prove as destructive for an economy as inflation.
Deflation in the Crypto Market
Cryptocurrencies, just like fiat money, are subject to inflation and deflation. When you study the tokenomics of a coin, you come to know whether the project is inflationary or deflationary. Although it may not be a perfect gauge to judge the quality of a network, it is reliable in most of the cases. There are a few projects that burn the supply of coins on purpose.
It is easy to see how deflation can appear in crypto. One method is protocol-level fee burning. Recent changes in Ethereum’s fee model ensure that the base fee paid for transactions is removed from supply. That burnt fee can make Ether supply growth negative when usage is high. This is a systematic way to link usage to token deflation. Planned token burns by projects is a much-appreciated way to keep prices stable or climbing. Some chains or tokens run regular burns that remove coins from circulation. $BNB has an automatic burn system that adjusts amounts of the burned tokens based on price and block activity.
Another method is a fixed-supply schedule that reduces new issuance. Bitcoin cuts new issuance roughly every four years in an event called “halving”. Each halving lowers the number of new coins that miners receive. The reduction in mining rewards makes new supply rarer over time. Markets often treat that reduced issuance as a scarcity signal.
These mechanisms matter for markets, but they do not decide prices on their own. Price follows both supply and demand. If a token is burnt but nobody needs it, price may still not appreciate. Some projects promise deflation but then fail to keep up the burn rate. A recent example shows $SHIB with falling burn activity and falling price, which highlights that planned deflation can be far less promising than it seems.
Inflation in the Cryptocurrency Market
Many coins, unlike the 21 million cap of $BTC, have unlimited supply that keeps on being unlocked forever either in the form of rewards for validators or in some other form. This chain of token issuance results in increased supply and decreased prices. A few bad actors abruptly unlock their supply without any prior warning or on very short notice. This was exactly what happened in the second quarter of 2024 when $AEVO unlocked 95.28% of supply within 32 days. When the new supply floods the market, market plummets headlong, leaving the investors crestfallen.
To manage inflation in crypto, projects can limit the total supply of tokens, use token burn mechanisms to remove coins from circulation, and adjust reward structures like staking or mining incentives over time. These measures help ensure that new tokens are introduced at a pace that matches demand. Investors can also track on-chain metrics, such as token issuance, burn rates, and network activity, to see whether a token’s supply growth is sustainable and whether inflation is likely to affect its value.
Conclusion
In brief, inflation and deflation affect cryptocurrencies in the same way as they do fiat currencies. Efficient and sustainable token burn mechanism or a hard cap on the maximum supply keep the supply in check and helps appreciate prices over time. Unlimited supply, haphazard and unplanned burning, or unforeseen massive supply unlocks cause inflation, eroding people’s investment unfairly.
