For most, ‘inflation’ is bad news. We’re seeing the worst of it in Venezuela now, and there are plenty of historical examples where communities and families saw their money’s value evaporate into thin air.
But inflation is not necessarily negative and can in some cases help stimulate the economy.
All major fiat currencies are based on the inflationary model, but what about currencies that are deflationary? The birth of Bitcoin in 2009 not only marked the first successful launch of a completely digital currency, but it was also unique in terms of the monetary policy that governs it.
Economics 101: Inflation and Deflation
When inflation occurs, purchasing power goes down. This negatively affects the cost of living and could even decelerate a country’s economic growth. However, inflation also has its benefits as individuals holding tangible assets (e.g., stocks or property) could take advantage of their currency’s decrease in value and sell at a higher price.
Furthermore, as a country’s national currency becomes cheaper, it will become cheaper for other countries to import goods from that country, which can stimulate domestic entrepreneurship and productivity.
From a consumer’s perspective, deflation may sound more attractive, as it generally means an increase in purchasing power. But there are plenty of scenarios where consumers do not benefit from an increase in their currency’s value. For example, paying back a debt may not be so attractive if the value of what you’ve borrowed today, is less than what you end up having to pay back.
Deflationary periods also impact the investment market, with investors less inclined to sell their assets.
Crypto vs. Fiat Currency
Economies need people to spend money to work. This is the reason why all major fiat currencies are based on a deflationary model.
The money supply of fiat currencies does not have a maximum cap – central banks have the option to print money, and during times of economic stress or when faced with a crisis, like, say, a global pandemic, printing more money and lowering interest rates are common tactics to encourage spending.
There’s a danger, however.
Most of us will remember how the 2008 Financial Crisis came about, and how bailouts can be seen as absolving executives from their responsibilities at the expense of wider society.
Against this backdrop, Bitcoin was created. It’s the world’s first cryptocurrency and it is governed by a deflationary policy.
Its total supply can never exceed 21 million Bitcoin, which is gradually released to the network, and to add to the asset’s scarcity, it is not uncommon for holders to lose their private keys and seed phrase – which effectively takes their funds out of circulation, forever.
But Bitcoin is not the only deflationary cryptocurrency. Over the past few years, new and alternative protocols and policies to drive up value have been developed in the altcoin space.
What are buybacks and coinburns?
When token burning occurs, a specific amount of cryptocurrency is permanently removed from circulation.
Think of a central bank that decides to burn a part of a fiat currency’s total money supply to cut down the rate of inflation and increase the value of the asset.
The burning – or destruction – of the coin is not to be taken literally. Instead, what happens is that with a coinburn tokens are taken out of circulation by placing them in a public wallet (also called “eater address”) from which these tokens can never be retrieved.
Funds allocated to such permanent removal from the market can either come from the team’s reserves, or as part of a buyback model they can be bought from the market and then destroyed.
Simply put, token burning is decreasing the supply while demand remains in place. Theoretically at least, this should increase buy pressure and works as an incentive for investors to hold on to their funds.
Coin burns are also a way for issuers to provide transparency to their investors – for example, some firms may organize buybacks and coinburns on the basis of their revenue. But there are other models as well.
Token burning is so important in the cryptocurrency space that some projects have even based their consensus mechanisms on the deflationary strategy; others have even gone so far as to create a self-destructing digital asset that burns a part of the total supply with each transaction.
Native Exchange Tokens
In general, native exchange tokens have three main functions; incentivizing market makers to boost liquidity, providing discounts to users, and powering new features (e.g., early access to IEOs, voting, listing new coins).
Coin burning is very popular among cryptocurrency exchanges that have issued their native tokens; while the coin’s utility encourages traders the use the tokens, coinburns provide a further incentive to purchase the tokens and hold on to them for longer period of time.
Binance, for example, uses 20% of its profits to buy and burn Binance Coin (BNB) tokens every quarter to reduce the supply of BNB in circulation. Binance has committed to continue this process until 50% of the total BNB supply has been burned.
Crypto derivatives exchange FTX has taken this a step further. Every week, FTX repurchases and burns its native exchange token FTX Token (FTT) funded by 33% of fees earned on the platform’s markets, 10% of the net addition to the insurance fund, and 5% of fees earned from other uses of its platform.
AAX, the next-generation cryptocurrency exchange that is powered by LSEG technology, will soon be launching its own native exchange token, AAX Token (AAB). The token has a fixed cap of 50 million AAB, each initially valued at 1 USDT.
AAX users will be able to use AAB to settle up to 100% of all trading fees on the exchange platform, with a baseline discount of 20% as well as a portfolio discount of up to 50% (based on the percentage of your portfolio held in AAB). AAB can also be used to unlock special features on the exchange, including trading bots and signals, social trading, as well as exclusive products.
Like with other exchange tokens, AAX will use coin burning to drive deflation and make AAB more attractive for long-term investments.
Compared to Binance and FTX, AAX has designed its coin to be more aggressive. AAX will use 100% of all trading fees of the platform’s futures markets to buy back and burn AAB tokens on a daily basis. All the tokens that are bought back by AAX will be destroyed – users can audit the process anytime on the blockchain – until 50% of the total AAB supply is burned.
Coinburns are also deployed for reasons other than deflation. Proof-of-Burn (PoB), for example, is a unique consensus mechanism that uses the concept of token burning to verify transactions on the blockchain.
To gain mining rights on PoB networks, miners have to destroy a specific number of tokens, which is similar to staking coins in Proof-of-Stake (PoS) systems but with the difference that validators are unable to access their tokens after they stop mining (as the coins have already been destroyed).
PoB addresses the energy-consumption issues of the popular Proof-of-Work (PoW) algorithm by restricting the number of miners that can verify blocks and matching them with the amount of crypto they have burned.
BOMB Token Experiment
One project that has taken coinburns to the extreme, as part of an elaborate monetary experiment is BOMB.
It is a self-destructing cryptocurrency that burns tokens equal to 1% of each transaction on the network.
Deflation is also facilitated by a fixed supply of 1 million BOMB as well as smart contracts that prevent the creators from minting new coins.
According to the creators, BOMB’s goal – instead of being used as a currency for day-to-day transactions – is to provide a decentralized hedge against inflationary instruments.
Deflationary Currencies: The Crypto Industry’s Ambitious Experiment
While major fiat currencies are based on an inflationary model to incentivize spending, cryptocurrencies utilize deflationary mechanisms to maintain a stable value-increase to encourage users to hold coins and utilize them to hedge against the general market.
Burning coins is a popular method to drive deflation, especially among issuers of native exchange tokens. In designing such a token, it’s about finding the right balance between incentivizing users to spend and holding.
AAX has designed AAB (aab.aax.com) with this balance in mind. For example, using AAB to pay for fees provides a 20% discount. But in addition, AAX also looks at the extent to which investors allocate their portfolio to AAB. For example, if AAB makes up 30% of a portfolio, that user can enjoy a 20 + 30 = 50% discount on all trading fees.
Launched in November 2019, AAX is the first cryptocurrency exchange to be powered by the London Stock Exchange Group’s technology provider LSEG Technology. It Is also the first exchange to have joined the London Stock Exchange Group’s Partner Platform, providing institutional clients ease of access to the crypto market.
Offering OTC, Spot, and Futures trading, quoting more than 50 cryptocurrency pairs and listing 5 perpetual futures contracts for Bitcoin, Ether, Litecoin, Ripple, and EOS, which can be traded with up to 100x leverage, AAX provides a secure, deeply liquid, ultra-low latency and fully compliant trading platform. http://www.aax.com.
Images courtesy of PxHere, Pixabay, Flickr/Zechariah Judy