Crypto’s 2023 losses raise concerns about its role as an inflation hedge, fueling the ongoing debate about its effectiveness.
How Does Inflation Affect Crypto?
Throughout an inflationary phase, fiat currencies such as the US dollar lose value. Crypto is not entirely inflation-proof, but it is likely to be less severely affected as conventional currencies.
This has caused many crypto traders to think that it might be a hedge against inflation. Unlike fiat currencies, which can be printed in unlimited quantities by central banks, most cryptocurrencies have a fixed maximum supply, making them inherently deflationary in nature. Some cryptocurrencies even have a burning mechanism, further reducing the circulating supply over time.
The deflationary aspect of cryptocurrencies is typically achieved through mechanisms like capped total supplies or scheduled reductions in block rewards, which control the rate at which new coins are introduced into circulation. This scarcity and predictability in supply make cryptocurrencies an attractive option for investors seeking a potential store of value during periods of inflation.
Crypto As A Hedge Against Inflation
In an ideal situation, the finite supply of coins is the fundamental feature that makes crypto a hedge against inflation. For instance, when Satoshi Nakamoto invented Bitcoin, he included a tight restriction in the source code that confined the number of Bitcoins in circulation to 21 million. Ever since, approximately 19 million coins have been created, with barely 2 million left. Nobody is able to edit the Bitcoin source code to boost its supply. With a finite supply, the coins that are in circulation will soon become rarer, raising demand and, as a result, the asset’s value.
Crypto, unlike gold, is also incredibly accessible. It can be sent from one end of the planet to the other in a couple of seconds. It is also available to everyone with a device and internet connection. Crypto has also been increasingly accepted around the world and has demonstrated price appreciation since its emergence. By holding onto crypto, it is possible to successfully safeguard your funds from the depreciating impacts of inflation (in the best-case scenario).
Is Crypto’s Ability To Hedge Inflation Eroding?
With prices rising at the fastest rate in decades, crypto hasn’t been doing well in the face of rising inflation in 2023. Food, gasoline, and commodity prices are drastically rising. This surge in inflation has led to increased uncertainty and market volatility, affecting various asset classes, including cryptocurrencies.
While some individuals have viewed certain cryptocurrencies as potential hedges against inflation, the overall performance of the crypto market has been subject to the same fluctuations experienced in traditional financial markets.
In March 2023, Bitcoin, and other cryptocurrencies skyrocketed in value as the Silicon Valley Bank-led financial crisis raises concerns about hyperinflation. The price of Bitcoin has risen to over $28,000 per Bitcoin, up from around $17,000 at the start of the year. The surge in the prices of crypto in the midst of the Silicon Valley Bank-led financial crisis has intensified the debate about their role as inflation hedges.
Reasons Why Crypto Can Be An Inflation Hedge
Cryptocurrency have the potential to function as an effective hedge against inflation, and this is attributed to various factors such as:
1. Limited Supply
Many crypto, like Bitcoin, have a fixed supply, meaning there is a maximum number of coins that will ever be created. This scarcity is in contrast to traditional fiat currencies, which can be printed by central banks, potentially leading to excessive inflation. The limited supply of certain cryptocurrencies can act as a hedge against currency devaluation.
Crypto operates on decentralized networks, reducing their reliance on traditional financial systems and government policies. In times of economic uncertainty or high inflation, this decentralization can provide a level of resilience and independence from inflationary pressures. In contrast to centralized financial systems that may face challenges during economic turmoil, crypto remains stable and less susceptible to disruptions in banking services or currency restrictions.
3. Global Accessibility
Crypto can be accessed and used by anyone with an internet connection, making them a potential hedge against inflation in countries with volatile or devaluing national currencies. Crypto can offer a viable alternative store of value for individuals seeking to protect their wealth from inflationary risks. This makes them a powerful tool for financial resilience.
Reasons Preventing Crypto From Being An Inflation Hedge
Cryptocurrency can provide a hedge against inflation, but only once it has established its fundamentals and gained widespread use. The problems that have to be properly addressed and tackled are:
1. Lack of Confidence
Inflation is caused by widespread scepticism of the central monetary system. This lack of trust, along with the turmoil produced by severe social and economic disruption such as the current, and severe supply chain interruptions, has led to the existing situation. At the same time, many individuals fear that crypto may lose its value as it is generally still a new asset class. This implies that it may be difficult for crypto to provide enough confidence and trust to investors and traders in the face of inflation.
2. Market Uncertainty
During periods of severe fluctuation and market uncertainty, crypto fails as an inflation hedge. Crypto often outperforms the market only in sustained growth settings, when their modest market capitalization in comparison to fiat currencies works to their advantage. Existing solutions are unsustainable because of their speculative nature and low volume of transactions. The financially unstable blockchains have an impact on the whole ecosystem, implying that long-term solutions are constantly sidetracked.
3. No Intrinsic Value
Generally, crypto does not have intrinsic value. Digital currency is effectively worth what its creators believe it is worth, which is a good illustration of what is known as the “Greater Fool Theory.” The entire market value of all crypto has already surpassed an incredible sum of $1.5 trillion, but there is also a concern that crypto is a virtual currency that is nothing more than computer code as it is not backed by anything other than the currency’s issuer to guarantee its value.
Crypto’s Future In The Face Of Inflation
Despite temporary setbacks, crypto has shown resilience and continues to evolve. To many, crypto has proven itself as an innovative and transformative investment opportunity. Though volatility exists, it also brings the potential for remarkable gains. During times of inflation, crypto can provide an alternative path for investors seeking diversification, as it operates independently of traditional financial systems.
The rise of blockchain and decentralized finance (DeFi) projects showcases a dynamic ecosystem that holds immense promise for the future of finance and various industries. As the crypto space continues to grow, crypto’s role as an inflation hedge will continue to evolve.
While some critics may question crypto’s effectiveness as an inflation hedge, many proponents believe that it can serve as a potential safeguard against the erosive effects of inflation. If you are a crypto enthusiast and have decided to purchase them because you have trust in the transformational power of digital money and blockchain technology, this may be the start of an exciting journey.
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