This article emphasizes the effects that token inflation has during times of low demand. The Bear market have already crushed crypto prices, but high inflationary tokens will likely suffer the most.
Many crypto investors have come to the space to fight the long-term effects of inflation for their respective national currency. At a moments glance, investors can see the decimation that has taken place over the past few months for all markets. Why invest in an asset if it continues to print daily red candles and underperform compared to the dollar? When asking this question, it is important to look at time frames. BTC does not outpace the dollar quarterly, but it usually does on a yearly basis, even more so on a multi-year timeframe.
In cypto those who seek to escape inflation can find themselves falling victim to inflationary tokenomics. Don’t get me wrong, some inflation within an ecosystem can be good, especially during an upward market. However, egregious inflation can highly affect the price action of a token, most notably during sideways or downward Bitcoin markets. Imagine a scenario where Bitcoin is trading at around 30,000$. The market sentiment is overall not great, but buyers and sellers are evenly matched.
As this Bitcoin continues to stay flat, an investor in token X is noticing their token price dropping slowly day after day. Token X highly rewards those who provide liquidity to the protocol the token is based upon (liquidity here is known as an LP). This investor in token X has provided 10,000$ in liquidity between a pair of token X and let’s say Bitcoin. Remember when providing liquidity, it usually comes in a pair of two tokens that are traded. As this token X protocol prints more daily tokens to reward LPs, the circulating supply is increased. Let us imagine an inflation rate of 10%.
Token X has a capped supply of 1 billion tokens. It has a current circulating supply of 500 million. This 10% inflation will introduce 100 million tokens per year. Let us pretend the token price is 3$ per token. As more tokens are printed, an increasing demand of 10% per year would be needed to keep this token at 3$. Given that we are in a bear market, the demand is highly reduced and many token holders are immediately selling their reward tokens as they receive them. Even if the demand remained exactly the same the token price would drop by 10% for the year.
Another important part about this example is that the LP, is slowly losing the initial value of the BTC they put in. As X token drops in value, less BTC would be withdrawable compared to token X, causing impermanent loss. This daily inflation rate of 273,972 tokens per day or around 1.9 million per week would need 821,000$ on the net buy side per day to remain at 3$. Again, being in a bear market makes this pretty unlikely, volume is probably low, and the demand just isn’t there. This token is likely to lose greater than .0273% of its value daily because of this. This is why tokens with high emission rates suffer greatly during bear markets. 821,000$ does not seem like a lot but remember that would be a net daily buyer side win of that amount. The token price would need to get through all of the sell pressure aside from just the LPs selling their rewards.
For more information on tokenomics and inflationary metrics check out our article on VettaFi [here]. So, token X would be 2.7$ at the end of the year assuming demand has remained exactly the same. Let us imagine that demand has reduced by half. The daily selllside pressure would overtake the token rapidly, this is why so many altcoins are down 90+% during the most recent bloodbath of digital assets. The token X investor would likely be staring at a token well under 50 cents with the continued inflation steadily increasing the supply. To make matters worse, said investor would have almost no Bitcoin left in their LP since the balance would be flooded with the devalued X tokens.
This is why we at Coinbusters are so interested in strong fundamentally based digital assets. Only the strong will survive these market conditions. If token X did not have a large treasury fund with cash and other stable assets, the founders would be forced to sell more token X to make ends meet, and pay their developers, further destroying the price. Tokens with simple inflationary tokenomics without other creative ideas under the hood are doomed to experience this phenomenon and slowly wither away during the crypto winter. Please remember none of this is financial advice, please stay safe out there!