Crypto is the newest investment option, ambitious investors are looking up as a hedge against inflation. But with the volatile market and sudden highs and lows of the digital currency, can cryptocurrency really be considered a good hedge against inflation?
What is an Inflation Hedge?
Before we dive into discussing what makes cryptocurrency a good hedge against inflation, it is essential to define what is an inflation hedge and why it is important for investors.
As the economies grow, so does inflation. The rise of inflation inversely affects the value of fiat currency, resulting in a fall in the purchasing power of money. Saved-up money suffers the most prominent hit as inflation rises and the importance of savings plunges sharply.
Therefore, to defend their savings value against inflation, individuals invest in products, markets, or commodities that can preserve their “real worth” even as the cost of products and services rises. In financial terms, this is known as hedging against inflation.
The goal of investing in an inflation hedge is that whatever they invest in will see price increases that are in step with, or even better than, inflation, allowing the investor to keep or even grow the purchasing power of their asset.
Especially in the post-pandemic arena, when inflation is at an all-time high, the goal of investors is
Since inflation is a significant issue right now as prices grow exponentially and central banks strive to control it by raising interest rates, it makes sense for consumers to put their money into something that will protect them from at least the worst of the increases.
Inflation and Cryptocurrency
Inflation indicates that the buying power of a currency will decrease over time. To put it another way, each unit of that currency – one dollar, euro, or bitcoin (BTC, -5.48 percent) – can no longer purchase as much as it once could. Inflation, central bankers believe, isn’t necessarily bad; at low, steady levels, it encourages people to spend, boosting economic development. However, too much of a good thing may be harmful; inflation can be painful if you aren’t earning a correspondingly greater pay, and fluctuating inflation makes budgeting difficult.
The Federal Reserve of the United States strives to control fiat currency inflation at roughly 2%. On the other hand, cryptocurrencies are decentralized, meaning there is no central bank. Cryptocurrency developers are involved.
The Federal Reserve of the United States strives to control fiat currency inflation at roughly 2%. On the other hand, cryptocurrencies are decentralized, meaning there is no central bank. Crypto developers fill this function, and specific decentralized autonomous organizations (DAO) also vote on a project’s tokenomics, but voting is decentralized among token holders.
Many coins have predetermined supply levels. For example, the Bitcoin protocol reduces the issuance of new bitcoin at a set pace, and once all 21 million bitcoin have been mined – which is expected early next century – no one can mint anymore.
Role of Cryptocurrency in Inflation
People typically safeguard themselves by investing in assets that preserve their worth over time because inflation has been a persistent danger to the value contained in money. For example, gold has traditionally been regarded as an inflation hedge, but crypto has become a more popular alternative in recent years.
Protection Against Inflation
Because Bitcoin is a deflationary asset, inhabitants of nations with unstable fiat currencies are increasingly utilizing it as a store of value to shield themselves from hyperinflation and growing costs of everyday goods and services. Unlike fiat currency, crypto cannot be manipulated as easily by raising interest rates or creating more money. Most significantly, the quantity of Bitcoin will never surpass 21 million, making it an appealing store of value.
Most crucially, Bitcoin’s supply will never surpass 21 million, making it an appealing inflation-resistant store of value. However, while Bitcoin has grown in popularity over the last year, the crypto market’s volatility remains a contentious issue.
The Crypto Market’s Instability
Critics say that the general price gain of cryptocurrencies over time is the primary cause for the growing institutional money in the crypto market. Bitcoin, for example, was still up 2% for the year despite a significant decline from its previous all-time high of approximately $30,000 in July. The annual increase reached 300 percent in August.
However, following Bitcoin’s 45 percent decline in May, many investors returned to gold, considering cryptocurrencies an immature industry that needs to mature.
Following Bitcoin’s 45 percent plunge in May, many investors returned to gold, seeing cryptocurrencies as an immature asset class that has yet to show itself as a stable asset class or a safe haven store of value. Any asset utilized as a store of value or a hedge against inflation must be durable and trustworthy. Gold has a lengthy history in this domain, despite the fact that it no longer backs sovereign currencies. On the other hand, cryptocurrencies have much too much short-term volatility to provide investors with the same level of assurance as gold.
The Bottom Line
Inflation is a complex economic concept that can be beneficial or harmful to a nation. However, the general consensus is that when it spirals out of control and rises too high, it can be disastrous. Although inflation stayed constant last year due to the Coronavirus pandemic, it is projected to grow in the near future as consumer spending increases and economies open up.
As a result, to protect themselves from future inflation, people and corporations invest in gold, real estate, and other assets. But, since its introduction, Bitcoin and cryptocurrencies have demonstrated the qualities of a hedge, like most reliable assets, they play a role during inflationary periods.