Inflation continues to be a serious concern for monetary policymakers across the globe. The recent COVID-19 pandemic has driven these concerns into the spotlight once again. This focus on the devastating effects of inflation can’t be ignored as the money supply is at an all-time high. Worst of all, the velocity of this money has decreased, meaning that people aren’t using their funds to stimulate growth but rather saving them for a rainy day.
What is Inflation?
Inflation is a decrease in the purchasing power of money. It occurs when the value of money decreases due to an influx in supply or a loss in faith in the currency. For fiat currency such as the USD, inflation always poses a very real risk since the currency isn’t backed by anything. When inflation kicks in, it’s usually reflected by a rise in the cost of goods and services.
Inflation in the Blockchain Sector
Cryptocurrencies are no different in the fact that inflation can wreak havoc if left unchecked. There have been numerous platforms that have suffered stagnant growth due to inflation. A perfect example of inflation in the blockchain sector occurred with early DeFi platforms.
These networks operated by minting new tokens every time someone joined their liquidity pools. Eventually, this led to a flood of LP tokens in the market. This influx of rewards resulted in a significant loss of value for these early platforms. Notably, it didn’t take long before the DeFi sector responded with the introduction of multiple strategies to combat inflation. Here are 5 ways blockchain developers fight inflation in 2021.
One of the most popular methods to reduce inflation is the integration of deflationary mechanisms. These systems are designed to remove tokens from circulation based on certain criteria. A perfect example of a deflationary protocol is token burns. A token burn refers to the act of permanently removing tokens from circulation.
In most instances, this task is accomplished by sending these tokens to an inactive wallet address. This locks the tokens into the address with no way to ever remove them. In turn, this strategy reduces supply and increases demand for the token. Notably, a variety of platforms integrate a token burn system directly into their core processes.
For example, you could have a DeFi platform that charges a 5% flat fee on every transaction. Half of this fee could go back to the community in the form of rewards. While the other half gets burnt, it’s also common to see some form of community governance used to determine the burn rate.
Another popular way to fight inflation is via buybacks. Buyback is a term used to describe the act of developers repurchasing tokens and holding them in the project’s wallet. Unlike token burns, these coins are not locked up for life. However, once they are repurchased, the developers can choose whether or not they want to reintroduce the tokens at a later date.
Buybacks are popular because they also increase the value of a token due to the added demand created by the buyback. Regular users gain additional ROIs when these occurrences take place. Buybacks can also be used to secure rewards for stakers and other network participants without issuing new tokens. This strategy eliminates the need to mint new tokens altogether. As such, it reduces inflations due to over-issuance.
Perhaps one of the most innovative ways that developers created to fight inflation is the introduction of multi-token platforms. These networks have a special rewards token that is different than their LP tokens and utility tokens. This strategy is highly effective because it reduces the overall amount of a particular token in circulation.
The introduction of rewards tokens helped the DeFi sector advance past its early inflationary concerns. Interestingly, some rewards tokens can be used in other services such as yield farming pools. This approach provides users with more profits and an easy way to secure a passive income.
Auto Converting Rewards
Another innovative concept gaining in popularity in the market is auto converting rewards tokens. These tokens are very similar to rewards tokens, but they automatically convert to a particular cryptocurrency daily. In most instances, these rewards convert to Ethereum. However, other networks support this strategy as well.
There are some huge advantages gained from this approach. For one, you never end up with an influx of rewards tokens. Additionally, regular users save on fees and time since their rewards don’t require any additional actions to cash out. This strategy eliminates the extra step of finding an exchange and converting your tokens. Consequently, auto converting reward tokens are becoming more common in the space as of late.
Non-fungible tokens are special digital assets that are designed to represent a single item. They are unique and can be verified using blockchain explorers. Recently, NFTs have seen an explosion in popularity. These tokens are now common in the DeFi community.
The singular nature of these tokens makes them ideal for fighting inflation. For one, NFTs are not valued based on their market cap like traditional cryptocurrencies. Instead, their scarcity and the personal connection an investor feels towards the token are the main contributing factors used to determine these unique digital assets’ value.
By rewarding users with NFTs, platforms eliminate inflation. Since these tokens are unique, each issuance doesn’t detract from the overall value of the token. Also, there has been an influx in the number of NFT markets and ecosystems in the sector. Now, users can take their NFTs and stake or lend them to earn more rewards without relinquishing ownership of the asset.
Fighting Inflation – The Battle Never Ends
There are a lot of ways to fight inflation available to blockchain developers today. You can expect to see even cooler and more effective strategies emerge in the coming weeks. For now, it’s recommended that you stick with projects that offer some form of buffer against inflation. In this way, you can better your chances of obtaining long-term ROIs.