Economics is a huge factor when we speak about currency success, for both crypto and fiat currencies. It is important to understand the difference between inflationary and deflationary cryptocurrencies, so you can make proper investment decisions.
Main difference between inflation and deflation
Inflation is a general increase in price levels in the economic system. It happens when the amount of money in circulation exceeds the amount of goods and services available. Usually, it occurs from central banks printing more money, which leads to loss in the purchasing power of the currency.
Deflation is a decrease in prices, which happens when there is a decrease in the money supply.
Inflationary and deflationary cryptocurrencies work the same way, operating in their respective networks.
Inflationary cryptocurrencies
Similar to fiat currencies, inflationary cryptocurrencies lose their value due to increased supply. Usually this happens by rewarding miners with block rewards. With the appearance of more coins, their overall value is diluted, leading to a decrease in the purchasing power of each coin.
This system has one main advantage - it encourages more participants to take part of the network, as miners receive incentives to continue mining.
A main disadvantage of the system is that those cryptocurrencies ate a subject to rapid price fluctuations.
Deflationary cryptocurrencies
On the opposite side, deflationary cryptocurrencies appreciate over time, as their supply decreases. This occurs by reducing the number of new coins created. This way, the value of the existing coins is being maintained.
A popular method to do this is “burning”. This means that a portion of the coins mined, exit from circulation permanently. That way the money supply is limited and the value of each coin as demand increases.
However, the slow growth of deflationary cryptocurrencies makes them less attractive for short term investments.
The effect on the market
Inflationary and deflationary cryptocurrencies are able to affect the whole crypto market. This happens when investors flock to one currency over another due to growing confidence in increased demand.
If we look back to 2017, we can see how the rise of Bitcoin caused a money flood in the markets. Furthermore, we can see how minor cryptocurrencies also are exponentially in price.
Deflationary cryptocurrencies can cause the opposite effect - they can decrease the demand for other coins.
For investors, it is important to understand how different types of cryptocurrencies work and what events can move the markets in one direction or another.
Supply-demand
An essential factor for successful investment is a good understanding of the supply-demand dynamics. The important thing to know is that each cryptocurrency is unique, and it is essential to assess each one individually before making a decision.
Volatility
In addition to the supply-demand dynamics, it is also important to evaluate volatility trends.
Volatility is measured by historical price data, and comparing it to the current conditions of the market.
Both inflationary and deflationary cryptocurrencies can be highly volatile, but deflationary coins are usually less prone to large price swings, because of their limited supply.
Inflationary cryptocurrencies are more volatile, as their money supply increases and causes major shifts in price.
Investment strategies
As mentioned, inflationary and deflationary cryptocurrencies have their unique characteristics which can impact the investment strategy.
For investors to make the right decision, it is important to understand the volatility of the market, as well as the demand-supply dynamics of the market.
Of course, it is also important to pay enough attention to the news and economic trends. Staying informed and prepared for upcoming changes can affect your investment strategies in a positive direction.
This is why it is so important to understand the basics of inflationary and deflationary cryptocurrencies, before making an investment.
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