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.
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 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.
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.
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.
Understanding the Concept behind Deflationary Tokens
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.
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:
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. 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.