Deflationary Asset Meaning
What is a Deflationary Asset?
Inflation is an economic phenomenon characterized by a currency losing its purchasing power. Traditional fiat money gradually increases in supply, which makes it subject to inflation by default. In contrast, a deflationary asset is one that typically increases in value over time due to a decrease in its supply.
A deflationary cryptocurrency is one where the supply of coins or tokens gradually decreases. The number of coins in circulation declines over time, creating scarcity and increasing its value. As a result, the purchasing power of a deflationary cryptocurrency increases over time.
How Do Deflationary Cryptocurrencies Work?
Deflation in cryptocurrency occurs in two ways – burning mechanism and capped supply or issuance (hard cap).
Crypto burning occurs when coins or tokens are sent to a burn or eater address (dead wallet) to remove them from circulation indefinitely. For instance, a platform or crypto community may repurchase coins or tokens from holders and burn them, which is known as a buyback-and-burn mechanism. Alternatively, some blockchain networks use smart contracts to burn a small percentage of their tokens or coins as a transaction fee or during minting. This is called a burn-on transaction. Crypto burning often appreciates the value of the cryptocurrency as its overall circulating supply gradually declines.
Some cryptocurrencies are hard-capped or limited to allow only a specific number of coins to ever be created. Bitcoin, for example, is capped at 21 million, meaning that only 21 million coins can ever exist. Once Bitcoin attains its maximum supply, supply and demand forces come into play. Bitcoin’s supply will remain stagnant, while its demand grows. This will create scarcity, leading to an increase in its value.
Bitcoin also uses a halving mechanism, where the block reward is reduced by half every four years. This slows the rate at which new coins are added to circulation.
In general, deflationary cryptocurrencies are perceived as assets that protect capital from inflation.
