How do inflationary and deflationary token models affect market liquidity?

What are inflationary tokens?

Inflationary tokens are for daily activities, so they are usually in abundant supply and hardly suffer from low market liquidity.

Cryptocurrency inflation refers to the decreasing purchasing power of a cryptocurrency over time. Inflationary tokens apply the same principles, using a crypto framework that aims to devalue the coin by increasing its supply.

An inflationary token allows for an increased number of coins in circulation through a mechanism that facilitates a steady increase in the supply of coins entering the market. Tokenomics in each crypto generally provides a predetermined inflation rate and determines the percentage increase of the token supply over time.

As more coins enter the market, the value of the coin decreases, at least in theory. This reduces purchasing power as users spend more coins to purchase assets. Some of the approaches inflationary coins take include mining and hoarding. This can encourage participation in the network, as users who mine or stake tokens often receive rewards.

An example is the inflationary crypto Dogecoin (DOG). In 2014, the creator removed the 100 billion supply hard cap, allowing unlimited supply of the token. As a result, DOGE decreased in value as supply exceeded demand.
What are deflationary tokens?

Cryptocurrency deflation refers to the increase in the real value of a cryptocurrency over time when the supply decreases or remains constant.

Deflationary cryptocurrencies take a different approach as they are designed to reduce token supply. Despite consistent demand, reducing the number of new coins should at least lead to their value being maintained.

The design of a deflationary cryptocurrency is token scarcity by reducing the supply and increasing the value of the token over time. The process hopes to gradually reduce the number of tokens and provide practical benefit without disrupting the balance or triggering market volatility.

Deflationary tokens, unlike their inflationary counterparts, do not have a fixed deflation rate in their protocols. Instead, the protocol determines the conditions under which tokens are removed from circulation, usually through a burning process. This mechanism reduces the supply over time, but the reduction rate is not set for a specific period of time and varies with network activity. For example, a coin with a 2% deflation rate will reduce the total coin supply by 2% annually. A deflationary token may have a fixed or variable feed cap that limits the number of tokens.

Creators of deflationary tokens may use direct or indirect mechanisms to destroy coins in circulation. A common way to facilitate a reduction in supply is through coin burn mechanisms, a process that permanently eliminates a portion of tokens from circulation. Alternatively, they can burn some tokens as gas fees for transactions on the blockchain.

An example of a deflationary cryptocurrency is Binance's BNB (BNB). Every three months Binance holds a burning event to get rid of excess BNB. Additionally, we keep a portion of BNB in transaction fees. Binance has promised to burn 50% of BNB supply.
How do inflationary and deflationary token models affect market liquidity?

Inflationary and deflationary token models refer to different economic policies adopted by cryptocurrency projects and strategies for managing token supply. These patterns can affect market liquidity in different ways:

1. **Inflationary Token Models:**
- Inflationary token models use a mechanism that increases the token supply over time. For example, the supply of tokens increases with each new block or the release of new tokens over a certain period of time.
- This model can increase liquidity by injecting more tokens into the market. New tokens can circulate among users, increasing volume and encouraging transaction activity.
- However, an overly inflationary token model could devalue the token and lead to loss of value to token holders. This may reduce the market value and liquidity of the token.

2. **Deflationary Token Models:**
- Deflationary token models use a mechanism that reduces the token supply over time or reduces the amount of the token in circulation. For example, a certain percentage of tokens are burned in each transaction, or the supply of tokens decreases with an ever-decreasing inflation rate.
- This model can increase the value of the token and provide increased value to token holders. This can increase the liquidity of the token because investors can hold the token believing that it will increase in value.
- However, an overly deflationary token model can very quickly reduce the amount of the token in circulation and reduce market liquidity. Additionally, the appreciation of the token may hinder transactions between users as they may be held to increase the value of the tokens.

In general, both models can affect market liquidity, but it is important to find the right balance between inflationary and deflationary token models. While a balanced token model can create solid liquidity, over-the-top models can negatively impact liquidity. Therefore, it is important that a project's token model is carefully designed and suits market dynamics.

3. **Horizontal (Fixed Supply) Token Models:**
- Horizontal token models are neither inflationary nor deflationary by keeping the token supply at a constant level. In these models, the token supply is usually determined at the beginning and is not changed later.
- This model can ensure that the token has a stable value and creates credibility among users. The value and supply of the token are known in advance based on the criteria set at the beginning, reducing uncertainty in the market.
- However, horizontal token models may limit the natural growth or development potential of the token. The token supply may need to be flexible to adapt to changing market conditions or to support the growth of the project.

4. **Elastic Token Models:**
- Elastic token models use a mechanism that automatically adjusts the token supply. In these models, when demand increases, token supply increases, and when demand decreases, token supply decreases.
- This model can stably maintain the price and liquidity of the token. When demand increases, increasing supply helps meet demand without reducing the price. When demand decreases, the decrease in supply preserves the value of the token.
- However, elastic token models can be complex and can lead to sudden fluctuations in the price of the token. Additionally, automatic adjustment mechanisms must be correctly designed and implemented for the system to function correctly.

These token models represent different approaches that affect market liquidity. Each has its own advantages and disadvantages, and it is important to choose the appropriate one depending on the project's goals and use case. The project's token model can lay a solid foundation for gaining the trust of users and investors and influence the success of the project.