Inflation is one of the most common monetary phenomena around the globe. It occurs when there is an increase in the price level of goods and services in an economy. This results in a decrease in the purchasing power of money, which leads to higher prices for basic necessities and other goods.
Many people believe that investing in cryptocurrency is a good way to hedge against inflation. However, this is not the case and in this article, we will explore why. But first, we must understand the causes of inflation to see how cryptocurrency interacts with it.
Causes of inflation
Inflation is caused by an increase in the money supply. When there is more money chasing after goods, the prices of those goods go up. The other main cause of inflation is demand-pull inflation. This occurs when there is an increase in demand for goods and services which outstrips the available supply. As a result, prices are pushed up.
To understand inflation, we can use the example of a simple market for apples. If there are only a few apples and many people want to buy them, the price of apples will go up.
In contrast, if apples were abundant and not many people wanted to buy them, the price of apples would go down. The same is true for the prices of goods and services in an economy. If there was an abundant supply of money and everyone was trying to spend it, the prices of goods and services would go up.
Can Crypto Inflation Happen?
Yes, for cryptocurrencies that have a growing supply of coins, crypto inflation can occur. However, for Bitcoin, which has a finite supply of 21 million BTC, crypto deflation is more likely to happen. This is because as demand for Bitcoin increases, the limited supply will become increasingly scarce, leading to higher prices. Here are some key points on why crypto is not an inflation hedge.
1. This in theory should make Bitcoin an inflation hedge but it has not responded as hoped because of its volatility. With such dramatic price swings, it’s difficult to argue that it’s an effective hedge against inflation. This is especially true for cryptocurrencies where the total supply is not known or can easily be increased.
Combined with the speculative nature of this asset class, the demand is not yet there to provide long-term stability against inflation.
2. Bitcoin has only been around for a little over 10 years. Because crypto is so new, there’s not enough past data to understand what role it plays as an investment. To hedge against inflation, you need an asset with a long track record that has shown to hold its value over time.
3. Crypto proponents have also cherry-picked data to make their case. They often compare Bitcoin’s ability to hedge against inflation when the price per coin was at its all-time high. However, this is not an accurate comparison because the price was artificially inflated due to speculation and mania.
4. Cryptocurrencies also still have a long way to go in terms of mainstream perception and adoption. If you’re holding crypto as an inflation hedge, you’re essentially betting that the mainstream will start using it as a store of value. This is a risky bet because crypto is still largely seen as a speculative asset class.
5. Another reason why crypto is not an effective inflation hedge is that it’s not yet being used as a currency. For Bitcoin to be an effective hedge against inflation, it needs to be used as a means of exchange and not just a store of value. However, crypto is still largely being held as an investment asset and not used for day-to-day transactions.
Although it can be argued that gold is seen as an inflation hedge but is not a medium of exchange, it is still more widely accepted by nation-states than cryptocurrencies.
As you can see, inflation in cryptocurrencies can occur if the supply of tokens can be tampered with. When denominated in fiat, increases in the price of cryptocurrencies may protect against purchasing power loss due to inflation. But due to recent data, crypto has not shown to be an effective hedge against inflation.
When asking “Can crypto inflation happen?”, the specific cryptocurrency needs to be analyzed. If an investor lives on a “Bitcoin Standard”, their purchasing power is protected against inflationary government monetary policy. This is because 1 BTC will also equal 1 BTC, no matter how much the government prints.
What Does Inflation Mean for Crypto Investors?
With inflation looming over the broader economic landscape, crypto investors must be strategic in how they allocate their assets. Inflation has caused other asset classes to also inflate alongside the growing monetary supply while Bitcoin and other cryptocurrencies have been on the decline.
This is partial because cryptocurrency projects have faced major collapses that caused a contagion within the markets. For example, Terra (UST), a stablecoin crashed and evaporated over $400 billion in total crypto market capitalization within just a few days. As a new market with ongoing experimental projects, the lack of stability and trust could be a key reason why crypto has not been seen as a safe haven asset during periods of economic upheaval.
Cryptocurrencies are still highly speculative and with long-term inflation likely paired with a lack of historic data, it’s difficult to make a strong case that crypto is an effective inflation hedge. For now, inflation means more decline in purchasing power for everyone, but for crypto investors, the outlook is uncertain. Speculation, regulation, financial contagion, and other exogenous factors will continue to shape how this emerging asset class behaves in an inflationary environment.
Final Thoughts
Bitcoin has the potential to act as a safeguard against inflation due to it not being regulated by any central bank, however, presently the market is unstable and prone to speculation. Being that bitcoin is relatively new, its value isn’t significant enough yet to outweigh these issues.
If denominated in Bitcoin, the total amount of Bitcoin owned and the equity in this monetary network is not diluted as if you were to hold cash. However, as a new asset and a population that still measures economic value in fiat terms, it is hard to ascertain what the purchasing power of 1 BTC will be in the future.
In other words, if you believe that more money printing is to come, then Bitcoin should hold its value due to its scarce supply, but it will take more time and data to prove this possibility. For now, it remains as a speculation rather than a hedge against inflation.
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