Inflation in Digital Assets — VegaX Holdings Research Report
The digital asset space has and continues to bring innovations to market — software technology, as well as creative solutions in monetary policies and economic guidelines.
This burgeoning new field is referred to as “Tokenomics.”
In traditional monetary systems, inflation is a factor of consumption, cost of labor, nominal interest rates, asset prices, increased demand (or lower supply), and central bank monetary and fiscal policies, among others.
However, in the digital asset space, each protocol has the option to set its levels of inflation for its particular token. This is unique to the space, and as such, there are countless examples of different so-called token emissions strategies.
In order to keep the scope of this piece relatively narrow, we will review two examples at opposite ends of the spectrum: we’ll review the tokenomics of the Osmosis and Bitcoin protocols.
Osmosis Labs (OSMO Token)
The Osmosis team states in their documentation that OSMO will be “highly inflationary at the beginning.” The primary reason is that, in order to attract users to a new protocol, those users must feel as though they are being appropriately compensated for their time.
As such, 300 million new OSMO tokens will be issued in year #1 (~821,917.8 per day), and each successive year will see that issuance reduced by ⅓.
Therefore, year #2 will have 200 million new OSMO, year #3 will have 133 million new OSMO, and so on. This issuance structure is called “thirdening” and is similar in makeup to Bitcoin’s “halving” which will be discussed later.
Newly released tokens will be distributed to a combination of staking rewards, liquidity mining incentives, developer vesting, and community pool according to the following distribution:
Staking Rewards: 25%
Developer Vesting: 25%
Liquidity Mining Incentives: 45%
Community Pool: 5%
From the figures above it is clear that the tokenomics structure of Osmosis is primarily geared toward rewarding users — 70% of new issuance goes to staking + liquidity pool incentives — as well as compensating developers who spend their time further optimizing the protocol (25% of new issuance).
On the other end of the emissions issuance spectrum is Bitcoin. New Bitcoins are generated via the Proof-of-Work mining process that works as follows: transactions yet to be confirmed (included in a block) on the blockchain wait in a queue called a mempool.
While the transactions wait to be included in the next block, specialized hardware devices, called miners, compete with each other to run these blocks of transactions through what is called a hashing function — which is meant to compress the list of transactions into an alphanumeric string of characters, called the block hash.
In order for a block to be published, its hash value must be underneath a specific threshold, which all participants on the network agree to in advance.
The first miner who successfully clears the threshold then publishes this block onto the greater blockchain and shares a copy of the updated blockchain around to all participants on the network. For their trouble — expending processing power via electricity — miners earn a “block reward” paid in bitcoin. This process of mining is the only source of “new” Bitcoins.
The block reward itself is dynamic and changes over time. Specifically, the block reward is cut in half (the so-called halving) every 210,000 blocks, roughly every four years.
Bitcoin is a finitely scarce digital asset, due to its supply being hard-capped at 21 million Bitcoins. This scarcity was a primary factor in the design of the protocol, as Bitcoin was always meant to be a hard asset able to reliably store value.
As such, the founder(s) and subsequent developers, miners, and users have maintained this low inflationary system to protect the asset’s purchasing power while sacrificing aspects such as rewards to users and explicit compensation for developers.
In the nascent space of digital assets, there is more than enough room for experimentation in monetary policy, as each protocols’ tokenomics are unique, and in many cases, is subject to change over time.
Therefore, “digital asset inflation” as it relates to the broader ecosystem is an incomplete framing.
Since each protocol takes a different approach, an investor must do their due diligence and research as to the tokenomics structure of a particular asset — and whether or not that particular structure suits their risk tolerance and investment goals.
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