Inflation and crypto:
Inflation is the process by which currencies lose value over time, causing prices of consumer goods to increase. The U.S. government, for instance, has printed more money than consumers actually need for decades. As the supply of an asset increases, the value of one unit of the currency decreases.
Say a hypothetical scenario where a currency has an annual inflation rate of 50%, this means if you can one-loaf of bread today using one unit of that currency, you’ll only be able to buy half a loaf of bread the next year.
Inflation strategies of some common assets:
Government currencies:
As the supply of central money is completely under the government control, the inflation is also under the government control.
For example the US inflation rate has been rising and is now close to 8%. What this means is that the value of goods you can get by spending one dollar is now 8% less than a year ago.
Gold:
Unlike government currencies, the value of gold is not completely under a central government. The price of an ounce of gold has marginally increased over the years due to the inflation of the dollar itself. Think of a hypothetical scenario where a new way to mine gold is discovered. Due to this new discovery, the total supply of useable gold available increases. This leads to an increase in supply, while the demand remains the same, meaning the price of gold would go down.
Cryptocurrencies:
Stablecoins: Stablecoins are cryptocurrencies pegged to a national currency, for example USDT pegged to the US dollar. Since they are pegged to a national currency, the value of it depends on the value of the underlying currency itself. Inflation in the supply of the underlying asset leads to inflation of the token as well, and you end up losing value over the long term.
Coins like Bitcoin / Ethereum/ Zcash: Most coins have a predefined inflation schedule. New coins are mined generally as rewards to the miners for running the nodes and verifying the transactions happening on the network.
The coins also have a max-supply which is a hard-cap on the total number of coins which will ever be mined. ( Ethereum does not have a hard-cap, it does have an annual mining cap though).
With the hard rules set for inflation, cryptocurrencies have the most predictable inflation rates.
A comparison of Inflation strategies of popular coins:
Bitcoin:
Max supply: 21M tokens.
Tokens mined: ~19M.
Inflation controls: Halving
As of now, approximately 19 million bitcoin have been mined. Around every ten minutes, miners process a new “block” and 6.25 bitcoins are added to the network. After a specific period the reward generated i.e. the amount of bitcoins minded gets reduced by half. (In 2024, the mining reward will drop to 3.125 bitcoin, and will decline by half again every four years until all bitcoins are mined.
Once all the bitcoin has been mined, it will be interesting to see what happens, on one-hand as no new bitcoins are produces, the inflation due to increase in supply is technically zero, on the other hand, it will be interesting to see how the miners react given one of their major incentives will be gone.
Ethereum:
Max supply: No;
Tokens mined: ~120M.
Ethereum does not have a capped max supply, but to keep inflation in check, the reward amount has been going down. Also there is a provision of burning tokens, i.e. deleting the existing ethereum to reduce the supply. If you see the supply over time, (reference 3), you'll notice the rate of generation of new coins has gone down.
The more interesting concept in Ethereum world is with Etherum2 with moving to the PoS validation where the rate of inflation is expected to go down significantly.
ZCash:
Max supply: 21M tokens;
Tokens mined: ~10M.
Zcash inflation almost precisely mimics that of Bitcoin. In early 2020’s ZEC’s annualized inflation rate was 28% – the highest among major cryptocurrencies, according to data source ViewBase. Meanwhile, bitcoin’s inflation rate was 1.44. This inflation rate goes down after each halving and is presently at 12%. This is expected to go down to 4% in about 3 years.
Similar to bitcoin, once the supply reaches 21M, the inflation due to increase in supply would be 0.
Monero:
Max supply: No;
Tokens mined: ~17M.
The tail emission: Although monero does not have a max-supply, the way inflation will be in check is by adding a keeping a very low fixed reward for miners once a specific number of coins are mined. Monero has a slight inflation rate designed to keep mining incentives stable yet still allow Monero coins to hold a strong value. With a long-term inflation rate at about 1%, which is similar to the rate of increase in gold, Monero incentivizes miners to join the network with solid reward.
The present world:
| Coin | Pre-mined | Capped-Max-supply | Privacy-focused | Max Supply | Existing supply |
|---|---|---|---|---|---|
| Bitcoin | No | Yes | No | 21M | 17M |
| Ethereum | Yes | No | No | - | 112M |
| ZCash | No | Yes | Yes | 21M | 10M |
| Monero | No | No | Yes | - | 18M |