School / Coin Inflation And Supply

Coin Inflation And Supply

Coin Inflation and Supply

Some cryptocurrencies have a finite amount of coins, while others have unlimited supply. How does that work and what role does inflation play for cryptocurrencies?

In today’s lesson, we are covering coin supply and inflation. Here’s what you are going to learn:

  • What inflation means and where inflation comes from.
  • What coin supply is and the difference between the different types of coin supply.
  • If having a lot of coin supply is good or bad.
  • The relationship between coin supply and inflation.
  • If cryptocurrency can protect you against inflation.
  • How inflation in cryptocurrencies works.
  • How much different cryptocurrencies inflate.

With so much to cover in the lesson, let’s move straight to explaining our key terms of the day: inflation and coin supply.

What is inflation?

The technical definition of inflation is as follows:

Inflation is the reduction of the purchasing power of a given currency.

In plain English?

Inflation is the effect that’s reducing the value of your money. Think of it like this. Everyone knows that a dollar in 1920 was worth more than a dollar in 2020. We’ve all read the stories of how much you could buy for a dollar back in the day, whereas today, you don’t get much for it. If a loaf of bread cost ten cents in 1920 and $1.50, inflation is the effect that happened in between. The purchasing power of your money, i.e., how much you can buy for a certain sum, has been reduced.

That doesn’t sound particularly pleasant, so it’s worth understanding the root of inflation.

Where does inflation come from?

Just like for any other good, the laws of demand and supply apply to currencies, too. The demand comes from us consumers. We need money to conduct transactions and do business. For regular currencies like the USD or the Euro, we call these fiat currencies, the state supplies the money. Every state has a central bank for that purpose. The central bank’s task is to manage the amount of money available. It ensures there is never too much or too little money in the economy.

Let’s recall that inflation is the effect of money losing its value. Why does any good lose its value? One reason could be that there is too much of it. We call this oversupply. If we have an oversupply of money, it starts losing its value. The central bank supplies too much money; it “prints more money,” and the money gradually loses its value. Computers, instead of giant printing presses, do this, but the basic process is the same.

Now that you understand inflation let’s explain our second key term: coin supply.

What is coin supply?

In simple terms, coin supply is the number of coins available. But there is a bit more to it because there are three different types of coin supply: maximum supply, circulating supply, and total supply.

Maximum supply

Let’s take Bitcoin as an example. We know that there will only ever be 21 million Bitcoin. This is programmed into the currency and cannot be changed. That’s why maximum supply means the maximum amount of coins that will ever exist. For Bitcoin, that’s an unchangeable 21 million, but other cryptocurrencies can add more coins or even reduce the number of coins available. This process is called “burning” the coins.

Circulating supply

Circulating supply is the amount of coins that are publicly available in the market. For Bitcoin, that would be around 18 million now. You could argue it’s less because some Bitcoin have been lost and can never be retrieved. Others have been held for years and are not really “available.”

Total supply

Total supply is the circulating supply of a coin and coins that are not yet available. For Bitcoin, that would be 18 million coins available now plus 3 million more still to come, resulting in 21 million coins.

What’s the difference then between total supply and maximum supply?

For Bitcoin, there is none, but another cryptocurrency might have a portion of its coins locked away for investors and developers. They aren’t allowed to sell the coins yet, so the coins are not publicly available, but in theory, they are there. And if the coin has no defined maximum like Bitcoin, we have a total supply, but the maximum supply could be infinite.

To recap:

  • Maximum supply: maximum amount of coins that will ever be available. For Bitcoin 21m, for other coins, this could be infinite.
  • Circulating supply: the amount of coins publicly available now. For Bitcoin 18m, for other coins, all the coins minus those that cannot be sold.
  • Total supply: circulating supply plus coins that are not yet available. For Bitcoin, these are equal. Other coins have shares dedicated to investors and developers.

Is a lot of coin supply good or bad?

It’s neither. Firstly, you can always break down coins into smaller units. Like the Dollar has Cents, Bitcoin has Satoshis, and Ethereum has Gwei. If you have a lot of coin supply, you’ll use a smaller unit to express values or use decimals.

Second, the value of a coin can rise, which can be reflected in a rise in supply for the coin. We discussed how the government can print more money and how this devalues it. But if there is a lot of value created, many people are working and doing business, there will be more demand for money. Then supplying more money is actually a good thing. Similarly, the value of a cryptocurrency can rise. If many developers use Ethereum to build new products and services, the demand for Ethereum rises, and it can make sense to supply more Ethereum as well.

A problem arises when the supply of coins exceeds the value it provides. Having a lot of Dollars is good, as long as they provide a lot of value. The same is true for cryptocurrencies.

We have already started connecting these two concepts. Now let’s explore the relationship between inflation and coin supply in more detail.

The relationship between inflation and coin supply

Many proponents of cryptocurrencies, especially Bitcoin, consider it to be insurance against inflation of fiat currencies. The Dollar has a theoretically infinite maximum supply, but only a fixed amount of Bitcoin is available. More inflation of the Dollar leads to it having less value, so people will try to exchange their devaluing Dollars for something that is rising in value: Bitcoin.

When you hear people talking about Bitcoin as “digital gold,” this is what they have in mind. Gold doesn’t have a fixed supply, but the amount of gold available is rising only very slowly. Now can Bitcoin become like gold? We don’t know that yet. Gold has been around for thousands of years, while Bitcoin has only for about a decade. But so far, the value of Bitcoin has only been rising.

What cryptocurrencies are the best insurance against inflation?

Bitcoin is considered to be the best because it has a fixed maximum supply. There are other cryptocurrencies like that, but Bitcoin is the oldest and has the most credibility. Ethereum is another popular currency but, unlike Bitcoin, it has no maximum supply, and it’s an even younger technology.

Can buying cryptocurrency protect you from the adverse effects of inflation?

It might, but we don’t know that yet for sure. Bitcoin is still very young, and, unlike gold, it hasn’t experienced a period of significant distress like wartime. Moreover, when the Covid-crisis hit in March 2020, Bitcoin also went down in value. That indicates that many people were not sure about the value of Bitcoin in potentially bad times and decided to sell it. Bitcoin also is yet to experience a period where inflation in fiat currencies is high. You could say it has not been tested enough yet.

On the other hand, it is a very young technology, and its value has been rising steadily even though it is volatile. Most people probably are not thinking decades ahead when buying Bitcoin but only about the near future. Its success as an inflation hedge will therefore depend on how much this can change.

Can cryptocurrencies also inflate?

Yes, of course. Bitcoin, too, has an inflation rate. Its fixed maximum supply means this inflation rate is steadily falling, though. All other cryptocurrencies have inflation rates, too, with some having a fixed maximum supply and others not. The difference between cryptos and fiat currencies is that crypto inflation rates are predictable and can be changed by their holders. For fiat currencies, central banks decide how much money to supply based on their best guess of how much is needed. For cryptocurrencies, all coin holders also have voting rights. Therefore, a coin’s community could decide on whether it wanted to increase or decrease the supply of a coin, and all holders get to vote on that based on their share of coins. You could argue this is more inclusive and makes inflation easier to control.

Can you protect yourself from inflation in cryptocurrencies?

Yes, through a process that’s called staking. Staking is akin to depositing money in a bank account to earn interest on it. By staking the coin, you lock it up and get paid a specific interest rate on your deposit. For example, if a coin has a 7% inflation rate per year, you could get a 10% interest rate for staking that coin, so you’d gain 3% in total. If that is worth it depends on the underlying coin and how you think its value against fiat currencies will develop.

Top cryptocurrencies and their inflation rates

To wrap it up, let’s take a brief look at a few major cryptocurrencies and their supply and inflation rates.

Bitcoin

Max supply: 21 million

Circulating supply: 18.7 million

Total supply: 18.7 million

Most of the Bitcoin that will ever be available have already been mined, with only 11% outstanding. As we mentioned, its fixed maximum supply means its inflation rate is slow and decreasing. That’s why the “digital gold” narrative surrounds Bitcoin. Below you see how its supply and inflation rate interact with each other.

Ethereum

Max supply: no hard cap – theoretically infinite

Circulating supply: 116 million

Total supply: same as circulating supply

Ethereum is the second-most popular cryptocurrency around. It does not have a maximum supply, which looks disconcerting at first glance. But it’s important to know that it has a fixed supply that is mined every year – 18m coins. That means that its inflation rate will keep steadily falling as the circulating supply is growing. It’s also worth knowing that it has a very active community, and a significant upcoming change could lead to this inflation rate being reduced even further. Below you can see its planned long-term inflation rate over a hundred years.

Cardano

Max supply: 45 billion

Circulating supply: 31.95 billion

Total supply: 32.07 billion

Cardano is a cryptocurrency that aspires to bring the advantages of blockchain technology to developing countries. So far, 71% of all coins have been distributed, and Cardano has a fixed maximum supply of 45 billion coins. It aims for an inflation rate of 7% annually until hitting this threshold.

Dogecoin

Max supply: no hard cap – theoretically infinite

Circulating supply: 130 billion

Total supply: same as circulating supply

Dogecoin has gathered much attention since Elon Musk publicly voiced his support for the coin numerous times. Initially derided as a pure joke, it has grown into being one of the biggest cryptocurrencies around. Although Dogecoin theoretically has no hard cap, its yearly supply is fixed at 5.256 billion coins per year. Therefore, Dogecoin’s inflation rate will be steadily declining in the future.

Ripple

Max supply: 100 billion

Circulating supply: 46.2 billion

Total supply: 100 billion

Ripple is a cryptocurrency that has been designed to create an alternative to payment systems like SWIFT. Since it holds and periodically releases some of its coins in escrow, its inflation rate has been reported to be as high as 20% annually. Moreover, only 46% of its maximum supply has been released so far, making it one of the most inflationary coins among the more significant cryptocurrencies.

Stellar

Max supply: 50 billion

Circulating supply: 23.14 billion

Total supply: 50 billion

Similar to Ripple, Stellar is designed to be an alternative for day-to-day payment systems. After initially having planned an annual inflation rate of 1% per year, the Stellar community decided to do away with this, and stellar will now be hard-capped at 50 billion coins of maximum supply.

Nano

Max supply: 133 million

Circulating supply: 133 million

Total supply: 133 million

Nano calls itself the “digital money for the modern world” and is yet another cryptocurrency designed as a payment system. Unlike its competitors, all of its tokens have already been released, and its maximum supply is fixed at 133 million.

Solana

Max supply: no hard cap – theoretically infinite

Circulating supply: 272 million

Total supply: 494 million

Solana is a blockchain, similar to the Ethereum blockchain. As such, it allows users and developers to build apps on top of its infrastructure. Like Ethereum, it has no hard limit in its maximum supply, but it aims to limit its long-term inflation rate to 1.5%.

Iota

Max supply: 2.78 billion

Circulating supply: 2.78 billion

Total supply: 2.78 billion

Iota is an open, feeless, and scalable distributed ledger designed to support frictionless data and value transfer. It aspires to become a “blockchain without a blockchain.” All of its 2.78 billion coins have already been issued.

Algorand

Max supply: 10 billion

Circulating supply: 3.08 billion

Total supply: 5.55 billion

Algorand is a blockchain, similar to its competitors Ethereum and Solana. It plans to issue 10 billion coins until 2030, when new coin issuance eventually stops, and the blockchain hits its hard cap.

VeChain

Max supply: 86.7 billion

Circulating supply: 64.3 billion

Total supply: 84.7 billion

VeChain is a blockchain that wants to make blockchain technology valuable for supply chains. So far, 74% of its coins have been released, but since mining rewards, the rewards for creating the coin, are paid in another cryptocurrency, VeChain has no built-in inflation.

Cosmos

Max supply: no hard cap – theoretically infinite

Circulating supply: 210 million

Total supply: 268 million

Cosmos is yet another blockchain that’s competing with Ethereum and other more established blockchains. Its inflation rate is flexible between 7% and 20%. The exact rate depends on how many of its coins are staked (meaning deposited) in its ecosystem. The more coins are staked, the lower the inflation rate, which is how Cosmos wants to incentivize its holders to retain its cryptocurrency.

Tezos

Max supply: no hard cap – theoretically infinite

Circulating supply: 848 million

Total supply: 878 million

Tezos is the last blockchain on this list. Like most other blockchains, it has no hard cap in its maximum supply but instead aims for a low long-term inflation rate. Its maximum inflation rate is 5.5%, which is higher than the long-term goals of its competitors Ethereum and Solana.

Current annual inflation rates

To wrap it up, here is an overview of the annual inflation rates of the different coins we reviewed:

comparison of crypto inflation rates

Even though some of these may have staking rewards that mitigate the inflationary effect somewhat its clear that coins are no equal in this respect.

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