Even while crypto has attracted millions as a refugee asset from money-printing regimes, its dirty little secret is that the entire business is dependent on inflation — the continual release of new tokens onto the market to encourage growth.
While Bitcoin is marketed as a completely solid currency with a completely capped supply, the network is now inflating at a rate of approximately 3.3% per year. For Ethereum, the number is slightly lower due to the deflationary EIP-1559, but at now, the vast majority of protocols are paying exorbitant fees for security, mining, growth, or liquidity.
The table below provides an overview of some of the largest companies that have paid for growth and security by minting and distributing new tokens.
How much do protocols spend to expand?
Essentially, cryptocurrencies can issue additional ‘equity’ (in the form of tokens) and use it to incentivize users in a variety of ways at the expense of existing token holders. With an inflation rate above 80 percent, a process like Osmosis requires daily demand of $1.4 million. This is nearly $31 million each day for bitcoin.
And that’s only the issuing of new tokens. Supply also increases as team tokens for Investors, Advisors, Teams, Reward (trading rewards, liquidity rewards).
Even while dYdX and SpookySwap have TradFi stats that are truly mind-bogglingly amazing, their prices have continually decreased over time.
Why? A major argument is that the token supply of these cryptocurrencies grows as rewards are distributed (SpookySwap with LP rewards, dYdX for trading rewards). Every new token that enters the market increases the supply pressure, which is likely to be sold off and drive the price down.
Not the same as structural demand.
TradFi depicts an entirely different image. There is a limit on the amount of stock that can be issued; it is not simple to obtain additional shares. Through buybacks, stocks generate structural demand (deflation). Both households and institutions purchase month after month. Price is essentially intended to increase.
During instances of panic selling in cryptocurrencies, there is not enough structural demand to force the price back up as token supply increase (in the form of VC unlocks, liquidity rewards, trading rewards, and tokens sold to pay for the project).
Due to this, cryptocurrencies experience FOMO-driven bubbles followed by protracted periods of depreciation.
As of this writing, Bitcoin compensates miners approximately $31 million every day, (albeit a modest percentage of daily flows), but liquidity that must be absorbed by entering capital to the tune of $11 billion per year.
0xHamz created this chart regarding the monthly issuance and inflation of tokens. The following cryptocurrencies generate roughly $102 billion in assets annually, with an average yearly inflation rate of 7%. (nearly as much as the 40-year high 8.3 percent inflation rate of the US dollar, for the record).
It is reasonable to conclude that the sector must attract $8.5 billion per month in fresh capital just to maintain its current price level.
Luna is an intriguing example of this inflationary/deflationary token issue because it illustrates both extremes. The deflationary process of seigniorage that Luna employed to mint its stablecoin contributed substantially to its outperformance over ETH. When the death spiral began, however, LUNA was forced to manufacture millions of additional tokens, causing the per-token price to plummet as the supply ballooned from 340 million to 6 trillion in a matter of days.
The right column depicts Luna’s supply inflation over a brief period of time.
Lessons Learned for Investors
Many people attempt (with some success) to swing trade around FDV bombs and farm yield into the depths of the ground; but, for the average retail investor seeking longer-term holdings, this approach is persuasive.
And what assets fall under the deflationary/non-inflationary category? After The Merge at some point this year, Ethereum will be the most obvious asset (hopefully). This will result in persistent structural demand pressures that are positive and deflationary, as well as a deflationary supply pressure.