Inflation is the general and sustained increase in the prices of goods and services in an economy over a given period of time. As prices rise, the purchasing power of money decreases, meaning you will need more money to buy the same goods and services you bought before. Inflation is often measured by indices such as the Consumer Price Index (CPI).
Main causes:
- Inflation Pull-Demand: This occurs when the demand for goods and services significantly exceeds the available supply, allowing sellers to raise prices. Basically, there is more purchasing power (money) in the market than there are products people can buy
- Rising production costs (Cost-Push Inflation): When the costs of raw materials, wages or transportation rise, companies pass these costs on to consumers through higher prices.
- Increased money supply: Excessive money printing by central banks can also lead to inflation.
In the world of cryptocurrencies, the concept of inflation is interpreted differently from fiat currencies (such as RON or USD), but the basic principles of supply and demand remain valid.
Intrinsic inflation (programmed supply)
Many cryptocurrencies have a programmed inflation rate in their protocol. This means that a predefined number of new coins are created and introduced into circulation at regular intervals.
- Rewards forminers/validators: Most blockchains reward miners (Proof-of-Work) or validators (Proof-of-Stake) with newly created coins for their effort to secure the network and validate transactions. This constant issuance of coins is a form of inflation.
- Purpose: This programmed inflation is often necessary to incentivize participants to maintain the network and to ensure an initial distribution of coins.
Intrinsic deflation (limited supply or burn mechanisms)
Some cryptocurrencies are designed to be deflationary or very low inflation, often by limiting total supply or implementing burn mechanisms.
- Fixed maximum supply: Bitcoin (BTC) for example has a pre-set maximum supply of 21 million coins. Once this limit is reached, no new coins will be created. The issuance rate halves roughly every four years (halving), which means that bitcoin’s intrinsic inflation is steadily decreasing, making it a long-term deflationary asset compared to fiat currencies.
- Burning mechanisms: there are protocols that periodically burn a portion of the transaction fees or available cryptocurrency, thus reducing the total existing supply in circulation. This can counter reward-generated inflation or even create a net deflation scenario.
Important:
In crypto, the concept of inflation can often be confused with pricevolatility. A sudden and unexpected drop in the price of a cryptocurrency can be perceived as a form of “inflation” because the purchasing power of that cryptocurrency drops drastically. This is not inflation in the traditional economic sense (which implies an increase in the money supply), but rather a price fluctuation dictated by supply and demand, market sentiment, news or macroeconomic events.
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