What happens when the supply of coins infinitely increases, if no real value is created?

by Kevin Koo

Introduction to Crypto-Inflation

Today’s post is a response to a conversation about ICO’s and what would happen if, in the real world, a government prints money. I call it crypto-inflation.

Before we begin, here is my disclaimer: I am not an expert on economics. My training and education have been on law. I studied managerial economics at masters level, but economics is not my forte. You’d best check with an economist.

So, what is crypto-inflation? It’s inflation, applied to Blockchain projects, and cryptocurrencies. Cryptocurrencies plus inflation, makes crypto-inflation.

Penn State University defines inflation as the rising price of a basket of goods and services, not reflected by increased productivity. Inflation means goods and services go up in price, but real output does not. It means that output is stagnant, but prices keep going up. You may be wondering how this works to crypto-inflation — we’ll get there soon.

Printing Money vs Inflation

Of the factors that cause inflation, the one relevant to this post is printing of money. You see, when a government prints money without any increase in output, that extra money enters the economy. It might be a convenient option for the government to settle its debts, or give salary to its employees.

But when many people have extra cash, they buy things at higher than average prices. There’s now extra cash chasing the same things. The willingness to pay more causes prices to go up.

So, printing money might give governments convenience in settling its debts — initially. But without increasing real value, it dilutes the value of money. Too much money and you get hyper-inflation.

Hyper-inflation as in 1920s Germany, after the First World War. A country that printed money to pay its debts, and found that what worked initially was harmful to the economy in the long run. Zimbabwe, as recent as 2007, also experienced hyper-inflation. You can see the photo which shows Zimbabwe paper money for one hundred trillion dollars.

ICOs vs Inflation

We think of an ICO as this: A fundraising exercise, in which a token or coin is sold to members of the public (contributors), in exchange for an established cryptocurrency. (This definition might be worth quoting.)

So, after a successful ICO:

  • The ICO project owners will have a lot of cryptocurrency from the contributors.
  • The ICO contributors have bought a lot of ICO tokens from the ICO project owners.
  • The ICO project owners will still have ICO tokens in their vault (typically) for their team, etc.

Let’s have an example of ICO project run by James. James sells 60% of ICO tokens for $1 million. In this example, he sells all of them to Jane, at a 50% bonus. (Lucky lady.) So Jane receives $1.5 million worth of ICO tokens, but pays only $1 million in cryptocurrency, like ETH. James keeps the balance 40% of ICO tokens.

At this point of time, only the ETH is worth something. The ICO tokens, meanwhile, are worthless until they are floated on a crypto-exchange.

James manages to float the ICO tokens on a crypto-exchange. Suddenly Jane can trade her $1.5 million worth of ICO tokens for Bitcoin or Ethers. Jane can trade her ICO tokens and get $1.5 million worth of ETH.

James, still retaining 40% of ICO tokens, can also swap them for $1 million worth of any cryptocurrency of his choosing. And that’s not forgetting that James got $1 million in cryptocurrencies from Jane, as payment for the tokens.

So, before flotation on a crypto-exchange, there is only $1 million worth of cryptocurrency. But after flotation on a crypto-exchange, there is now $3.5 million worth of cryptocurrency.

ICO tokens on a crypto-exchange can be converted into prominent cryptocurrencies. And prominent cryptocurrencies like Bitcoin or Ethers can be converted into fiat currency. So the question is then, does this increase in the circulating crypto-money lead to crypto-inflation?

Crypto-Inflation vs Increase in Real Value

If you recall the discussion above, inflation happens when there’s more money than output. Too much money without increased output leads to inflation. But the world of Blockchain projects is a world full of exciting prospects and possibilities.

Just today I was telling my friend about PowerLedger, the Blockchain project that enables peer-to-peer trading of energy. That project raised AUD $34 million. My friend, who is himself in the energy industry, was suitably impressed. I advised him to look into the PowerLedger project and consider using their solution.

There are countless Blockchain projects that are now being launched that impact societies, businesses, and governments everywhere.

I could go on and on, but I think you get the idea. There’s a lot of value being created in the Blockchain world! Thus, the increasing number of cryptocurrencies will probably not cause crypto-inflation!

(This has to be qualified, with the expectation that only good Blockchain projects that deliver real value will attract funding.)

Instead, what could happen is that yes, the supply of crypto-money will increase.

But crypto-projects long past their ICO stages will become widely adopted, and require the use of ICO tokens. Real users will drive the use of these Blockchain platforms, driving up the demand for the platform’s tokens. Real value will have been created.

Concluding thoughts on crypto-inflation

I expect that in the near future, society will incorporate Blockchain solutions into their daily lives. I expect that governments will start to use Blockchain to keep records. I expect that businesses will use Blockchain solutions, for things like supply chain.There’s a lot of value to be created.

So perhaps, the increased amount of crypto-money that is created from ICOs should not be a concern for regulators. Instead regulators should open up a space for startups and innovators to experiment with Blockchain, and see how they can create new projects which need to use tokens.

Before we end, if any regulator wants to talk to our team about regulations for curbing crypto-inflation — feel free to get in touch. It would be a great honour for us.

Thanks for reading.