The case for and against deflationary tokens
By MD, cryptochefs. All views are MD’s own.
We were having a discussion in the team discord the other day about deflationary tokens. This was relevant, as our current project is a deflationary token. We’re active in most of the places you’d expect low-cap crypto-pioneers to be hanging out, so there’s usually one us listening into the chat! Two of the team had seen a conversation which went broadly along the following lines: “Deflationary tokens are rubbish. Because they are deflationary they always end up going down in value!”
Luckily I wasn’t there, or we’d have opened up an impromtu economics lesson and I’d have cleared out the discord. But it got me wondering how many people have the same view.
To address this we first need to unpack what ‘deflationary’ means. And no, it’s not the same as deflation. In a nutshell it refers to when a supply of a thing goes DOWN. It’s the opposite of inflationary, where the supply of a thing goes UP.
Now, what does economics 101 tell us? It’s that the price of anything, absolutely anything, is governed by supply and demand. Increase supply against fixed demand and the price goes down. If apple producers suddenly double their yield and people are still eating the same number of apples the price of apples will go down, as the apple producers compete to sell their stocks of apples. The inverse is of course true, and if we reduce supply against a fixed demand prices go up. If it’s a bad year for apple growing and the apple yield is 50% of normal, and demand for apples is constant, then each apple goes up in price to reflect that scarcity of supply.
Something that is deflationary has a reducing supply. In the case of crypto with automatic burns this deflationary nature is baked into the smart contract. And when we reduce supply and keep demand the same we KNOW that thing goes up in value, as it is more valuable in increased scarcity.
So the people at the top of the discussion had it entirely the wrong way round. Deflationary tokens don’t go down in value because they are deflationary. Something that is deflationary should tend up in value. But they had one thing right — we are certainly seeing quite a few tokens with automatic burns dropping off in value. So what is happening here?
Well, I would argue that we are dealing with the other side of the equation, with the DEMAND side. These tokens are deflationary so supply is going down, we know that. But demand is not fixed, and it’s demand that goes over the cliff, usually when people begin to ask ‘hey, what’s the VALUE in this thing I own?’ And so often the team developing the token hasn’t baked that value into the smart contract, and doesn’t seem to be doing the work to create that value after launch. Because believe me, planning for and creating value is work. But it’s so worth it!
So to round this out, it’s all about supply and demand. If you have something where the supply will reduce (aka deflationary), be happy, reduced supply is good for you! BUT, pay more attention to where you think demand will lie, as both things are important. A huge supply and a low supply of something that no one wants is worth exactly the same. Seek out tokens and projects from teams that know what they are doing, who have put the hard yards in pre-launch to build a good product, and who intend on continuing to build value into that product in the weeks, months and years ahead.