Cryptocurrencies were created to prevent the manipulation of markets by centralized financial institutions. They should be immune to inflation, but the truth is a bit different…
What is inflation?
Inflation is the rate at which currency loses its value. Do you remember when you were younger? Prices were lower, right? When the purchasing power of a currency falls, the prices rise in an attempt to compensate for the loss.
Demand and supply. The iron law of the market. Just like goods and services prices can vary due to demand and supply, so does vary the cost of money. When money is cheap, credits are easy to obtain and interests are low. Then the speculative, risky markets, thrive.
When due to any disruption, wars, catastrophe, lack of resources, unrest, recession, the economy of a country stalls, then the mass of money is suddenly larger than the pool of goods and resources. Money loses value, as purchasing power shrinks.
Trying to control inflation and monetary flow, central banks withdraw money from the system (or print money, like the US government, always prefers to keep slightly more money than the circulation really needs). A lack of money in the system is not good for the economy. That’s why central financial institutions (central banks or FED in the USA often dictate the interest rates, trying to make credits more expensive, curbing the risky speculations, in an attempt to stabilize inflation.
Is inflation good or bad?
Despite the fact that it has to do with the devaluation of a currency, inflation is not always a bad thing. A slight inflation rate can stimulate spending, investing, and borrowing. In a healthy economy, inflation will cause prices to rise, but the wages follow, and overall there is growth.
Slight inflation is beneficial for lending money, as those who borrow can repay the loans with money that is less costly than the money they borrowed. A low inflation rate can protect from the perils of deflation. If deflation occurs, prices react more violently and unemployment is on the rise. Overall, for the entire economy, it is better to have low inflation (around 2%) than to face deflation.
Hedge against the inflation
The threat of inflation is also a good motivation for investors to diversify their portfolios and keep certain asset types as stores of value. Seen as safe especially are the real estate assets and tangible commodities.
Real estate has the added benefit of being able to generate income, as rental prices usually follow the price increase of inflation. Commodities don’t generate income, but their prices tend to stay afloat of inflation. This goes for derivatives based on commodities. For the more daring investors, there are inflation-indexed bonds, as well as leveraged loans.
Cryptocurrency and inflation
Cryptocurrencies were created to counter whimsical fiscal interventions of central banks. In theory, inflation and rising inflation rates should have no influence on the value of cryptocurrencies, whatsoever.
Cryptocurrencies are guided by the rule of supply and demand, without a central authority to declare interest rates. Bitcoin has algorithmic systems in place that ensure scarcity, in theory, making it possible for its value to rise forever.
Other coins, altcoins, often include “burn” rules. Namely, some coins monitor trading activity and incentivize network use by deleting, removing tokens from circulation – i.e “burning” coins to prevent inflation and limit the supply in circulation, thus raising the value.
The volatility of cryptocurrencies means that crypto investments are very much keyed to knowledge. Simply put it is very important to keep track of the crypto markets, new projects, as well as how the ongoing projects introduce new features.
Crypto markets move very fast, so it is of utmost importance to keep track, as news from the world of crypto can be a good signal of market moves. That’s why aggregators, like DEXterlab are precious. One place where you can keep track of the moves of digital assets is invaluable to smart investors.
Cryptocurrency as a hedge against inflation
Gold was traditionally a hedge against inflation, as the value is always on a slow rise. Bitcoin, the first cryptocoin created, was early on dubbed “digital gold” as its scarcity method is mimicking that of gold.
However, due to the large influx of financial institutions to Bitcoin trading, this particular coin has lost much of its “store of value” role, turning into an interests rates index. That’s why the rising inflation rate is hitting the value of Bitcoin the hardest.
There is no reason to despair, though, as the crypto market is much wider than Bitcoin price, as many blockchain networks still operate under supply and demand rules, basing their value on actual use case value.
Cryptocurrency as safe haven in the middle of inflation
In countries with unstable economies, under the threat of hyperinflation, cryptocurrency is a short-term solution to store value. This is especially true for citizens of Latin America and Africa, where crypto adoption is high, specifically for this reason.
That’s why news of crypto laws is important. For example, at the beginning of 2022, the Indian legislature has finally recognized crypto assets issuing cryptocurrency taxation law. In case you wonder how is taxing ever a good thing, here’s the catch.
By recognizing cryptocurrency as either assets or stock, the government is legalizing crypto transactions, mining, and trade. This allows the citizens, especially the unbanked citizens to gain access to savings, lending, borrowing, and many other financial products otherwise inaccessible to them.
If a central bank is weak, and the national currency is under heavy inflation, crypto becomes a good way to not only protect the value for the citizens but also help them thrive during the inflatory circle.
Cryptocurrency as a development bank
The rising inflation rate, especially during hyperinflation can freeze economical growth and spell doom for a country hit by runaway inflation. Imagine a young business or starting a business in this hostile environment.
It seems that such business is doomed in the midst of rising inflation. However, the cryptocurrency can open access to healthy markets, independent of central banking systems, fiat banking which is hit by inflation.
Just like the visibility of a business is depending on website optimization, exposure to crypto can optimize cash flow, access to credit lines, and other lifeblood of growing business. While there are certain cryptocurrencies affected by the rising inflation, there are a lot of blockchain networks with strong use cases that are immune to inflation.
It’s all about changing the channel and finding solutions. For example, a lot of crypto companies are switching to email marketing because their target audiences are not using the commonly used channels, like Discord or Slack. You have to go where your audience is!
Cryptocurrency will be affected by the rising inflation rates, especially the crypto assets that are of high interest to financial institutions, big companies that added crypto to their balance sheets, and other high-profile investors.
Companies seeking to avoid the impacts of high inflation rates, can turn to Decentralized Finances (DeFi) and find less troubled waters there. The crypto markets are maturing, and they are less and less depending on the moves of traditional markets, making them a perfect hedge against inflation.