Blockchain technology has ushered us into a digital era, including in finance. More people are opening their minds to the idea of dealing with digital currencies. This progress is something most of us never expected. However, the crypto sector is continuously booming to unprecedented levels. The global pandemic was a situation that led to crypto getting their moment to shine.
Currently, there are over 11,800 coins in the market and still increasing. The crypto market cap is swinging over $2 trillion and is expected to continue on an uptrend. Therefore, it is crucial to note that the economic models of some coins in the market are the reason behind their growth. These coins are deflationary tokens, a booming economic model in the newer coins.
What are deflationary tokens, and how are they influencing crypto projects to reach newer levels? Stay tuned for a clear explanation and my opinion on how they can boost crypto projects’ value.
Understanding the Concept behind Deflationary Tokens
A few of you may confuse the concept of deflation in traditional finance and cryptocurrencies. While in traditional finance, deflation is a bad thing, it is a positive element for cryptocurrencies. In traditional finance, deflation refers to an asset’s decrease in price due to certain conditions such as over-minting.
A deflationary crypto decreases in its market supply as time goes by. This factor implies that users or the project’s team will participate in activities that reduce the coin’s supply on the blockchain. A common way to achieve this end is burning tokens.
A point worth noting is that cryptocurrencies with a finite supply are deflationary by default. They achieve this status since as long as investors buy and hold the coin, its supply reduces. An excellent example is Bitcoin, the king coin in the crypto market and retaining the highest dominance to date.
According to many crypto enthusiasts, deflationary tokens are here to outsmart DeFi. Some of us may still be skeptical about this factor as DeFi shows promise in building web 3.0 into the future. However, projects such as Ethereum turning to deflationary token mechanism raises the question of what the fuss is about. Before we answer that question, let us have a look at how the deflationary token model works.
How Do Deflationary Tokens Work?
As mentioned earlier, deflation in cryptocurrencies mainly involves burning tokens from circulation. The confusion comes in how exactly a blockchain destroys its tokens. It is not a literal activity as it consists in locking the tokens in a wallet without the private keys, rendering them inaccessible.
Platforms employ two types of burning mechanisms: buyback and burn and transaction burning. Buyback is a self-explanatory mechanism as it involves the platform buying back tokens from holders and locking them in an inaccessible address; a platform may use part of its profits to execute this process.
As for burning on transactions, a platform employs a smart contract that automatically burns part of transaction fees. This mechanism heavily depends on the number of transactions on a platform; the more the transactions, the more tokens the platform burns and vice versa.
Major Projects Turning to Deflationary Mechanisms
Some argue that Bitcoin’s finite supply is the reason behind the coin’s great value. Crypto experts call it both inflationary and deflationary. However, focusing on the deflationary side, the coin undergoes halving every four years, reducing its circulation in the market.
Since its halving in 2020, the coin managed to reach a new all-time high, gaining the interest of both retail and institutional investors. It currently stands as an excellent option as a store of value more than an investment.
Nonetheless, Bitcoin is a glimpse at how deflation may work on an asset with a finite supply and high demand; other projects are shifting into deflation as their tokenomics model. Ethereum and Binance are two notable projects using deflationary mechanisms to their advantage.
Benefits Crypto Projects Can Derive from Deflation
There are several advantages both investors and projects can derive from deflationary tokens. Beyond everything else, deflationary tokens wish to solve the issues with traditional finance. Going against popular outcomes, deflationary tokens have a positive impact on the crypto space. Here are some of the ways projects can benefit from them:
- Increase A Coin’s Value
In the fundamental law of supply and demand, an increase in supply leads to a decrease in demand. Deflationary cryptocurrencies focus on reducing their supply in the market, increasing their scarcity, and heightening their demand. Why, you may ask? It is common knowledge that rarer things to get are more enticing than those which are readily available. Using the same concept, investors have a stronger attraction to scarce coins than those flooding the market. In the long run, this will lead to an increment in the coin’s value.
- Generating Profits
During the recent bull run, deflationary tokens have been taking the spotlight. This element directly contributes to investor interests as they amass more profits. Another scenario for the same is if a platform decides to buy back coins from holders. The whole process leading to the coin burning will profit those who choose to short their coins. At the end of the day, the expected results will be a boost in value after burning.
- Removing Extras from the Market
Unsold tokens in circulation are detrimental to the progress of a cryptocurrency. Deflationary mechanisms help a project to remove them from circulation instead of flooding the market. Furthermore, if there were coins distributed incorrectly, burning would be beneficial to rectify the mistake.
The number of deflationary tokens entering the crypto market today is staggering. We have heard of Burny and Boom tokens, which are some of the popular deflationary tokens. Nonetheless, deflation seems to be catching the eye of big fish in the industry, as is in the case of the Ethereum EIP-1559 upgrade.
This move is an eye-opener for many who were discrediting deflation as a positive impact on the industry. I think it is time for deflation to take over crypto markets, providing alternative ways to store value. Lastly, it is not a matter of how, but when the coins manage to control the crypto market.
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