Inflationary vs. deflationary cryptocurrencies, Explained

Some cryptocurrencies are inflationary because the supply of coins increases over time. Inflationary cryptocurrencies use a combination of predetermined inflation rates, supply constraints, and mechanisms for distributing tokens to maintain the supply and incentivize participation in the network.

Looking at their monetary systems, cryptocurrencies have various coin-creation and supply mechanisms. Inflationary cryptocurrencies have a steadily increasing supply of coins entering the cryptocurrency market. Typically, there is a predetermined rate of inflation set, which specifies the percentage increase in the currency’s total supply over time. Moreover, the inflationary token’s maximum supply is usually fixed or variable, setting the total number of tokens that can be created. Once the maximum supply is reached, no more tokens can be minted.

Nonetheless, different cryptocurrencies still have varying tokenomics, which may be adjusted over time. For instance, Dogecoin (DOGE) once had a hard cap of 100 billion tokens until the supply cap was removed in 2014. With this decision, DOGE now has an unlimited supply of coins.

How does an inflationary cryptocurrency work? Inflationary cryptocurrencies distribute newly minted coins to network participants utilizing dedicated consensus mechanisms, such as proof-of-work (PoW) and proof-of-stake (PoS), through which new coins can either be mined into existence (Bitcoin (BTC)) or distributed to network validators (Ether (ETH)).

Through Bitcoin’s PoW consensus mechanism, miners validate transactions and are rewarded based on who solves the puzzle first. In PoS, when a block of transactions is ready to be processed, the PoS protocol will choose a validator node to review the block. The validator checks if the transactions in the block are accurate. If so, the validator adds the block to the blockchain and receives ETH rewards for their contribution, generally proportional to the validator’s stake.

In some cryptocurrencies, the distribution of new tokens can be influenced by governance decisions. For example, decentralized autonomous organizations (DAOs) may vote to release treasury funds, change staking rewards and set vesting periods, ultimately affecting the currency’s inflation rate and the distribution of new tokens.