The Inflation, Then Deflation, Of STEEM

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Everyone is aware that STEEM is inflationary. The supply is expanding. This is a bad thing according to many since it makes each token less valuable. Each person's stake is reduced by the inflation amount. The only way to offset this is to increase one's stake.

For example, the inflation rate is roughly 8.5% now. That means if one has 100 tokens, it will be worth the same as 91.5 tokens in a year (if nothing else changes).

As you can see, when this happens in the fiat world, purchasing power is reduced. This is why inflation is fatal. Consider the fact that the United States Federal Reserve has a mandate to reach 2% inflation. All things being equal, this would reduce purchasing power by 2% a year, or 20% over a decade. Obviously, in the real world, nothing is that simple and there are many other variables that come into play. Thus, we are doing this more for illustration purposes.

Expansion of the money supply should lead to higher prices since we have the "too much money chasing too few goods" situation. This can happen but is not guaranteed. Plus, we have other aspects to consider. Technology can reduce the cost of goods leading to an actually price decrease. Recessions or economic slowdowns can also negatively affect prices. My point is that nothing is that simple which is why the central banks have a very difficult time maneuvering the economy.

So, with STEEM, is inflation a bad thing?

In the world of crypto-economics, what takes place elsewhere is different here. One of the biggest difference is that an ecosystem like Steem is a cooperative. The STEEM coin is a stake in that ecosystem. The stake is held by both developers and users. Essentially, the goals are aligned. Both parties benefit from a thriving ecosystem that grows in value.

The other aspect to consider is the reason why STEEM is created. Tokens are designed to incentivize behavior. People on Steem receive the coin for many different reasons. Witnesses earn STEEM for running the software that handles and validates the transactions. Content creators receive upvotes which are worth STEEM. Curators get paid for providing said upvotes. And finally, those who power up, i.e. invest in the blockchain, see their holdings grow by being paid a percentage of the inflation pool.

In other words, these different parties are paid for their contributions to the ecosystem. This is their reward for adding value to the blockchain. Over time, the idea is to grow the network at a pace faster than the inflation rate.

An inflating token, all things being equal, will become less valuable over time. This only makes sense since the units are diluted. Without growth, one's stake, which token ownership denotes, is lessened.

However, there is a caveat to all of this. A thriving cooperative, which is receiving a significant increase in value from its members, will see a point where the token price will increase in spite of the continued token expansion. The reason for this is simply supply and demand.

As the value of the network grows, more people get interested and partake. This stimulates more activity, providing further increase in value. In this instance, we will see the concept of too many people chasing too few tokens. The demand will exceed the supply. In that instance, there is only one way to acquire a greater stake: bid up the price to buy the tokens people are willing to sell.

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When that happens, relative to other assets, the same STEEM token will buy more (not less). Here again, nothing operates this cleanly in the real world since markets are constantly moving the prices of all assets. That is why the price of gold will go up or down against the USD regardless of what the Fed is doing (at least in the short term).

Nevertheless, I think we see the point. Over an extended period of time, when the value of a crypto-economic system grows and more people are joining, the value of the token rises due to demand. This will more than offset the stated inflation rate that is programmed into the blockchain.

It is for this reason that the inflation rate of most crypto-economic system means very little. Obviously, if it is a blockchain that has very little happening, then that could be a problem. However, on Steem, where we see monthly advancements in the areas of both users and development, it carries little weight. In fact, the inflation rate is crucial for attracting newer users.

Think about it this way, how would the reward pool look if there was no inflation? What incentive would there be for newer people to post and comment on the blockchain? Why would developers, who are also stakeholders, go through the headache of coding and upgrading applications if they knew that newer people would not be using the ecosystem?

The long and the short of it is none of those parties would participate. Remember, tokens are to provide incentive to add value to the ecosystem. This is where the growth comes from. It is necessary until the positive feedback loop of the network effect is achieved.

Once that happens, we have a situation where the value of the entire system grows at an ever growing rate compared to the inflation of the token. Eventually, the inflation rate drops to 1%. At that point, we could still see a growing ecosystem with a relatively finite number of tokens being created.

It will be a different economic world.

Fun times ahead.

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