Since its conception with Bitcoin in 2009, crypto has been making waves in finance and beyond. As a digital currency, though, it’s undeniable that the crypto market is also extremely dynamic. In November 2021, we reported that Bitcoin reached an all-time high of $68,530. The opposite happened in June 2022: Bitcoin’s value dipped below $20,000 for the first time since late 2020.
A lot of things can affect the value of a crypto token. One major factor is the principle of supply and demand. Others include the cost of crypto mining, the number of competing crypto tokens in the market, and recent government regulations regarding crypto’s use. At this, you may ask: what about inflation?
Inflation’s been a big topic in the news recently, and you may be wondering if it can affect your crypto investments. We aim to answer all your burning questions on inflation and crypto below.
What is inflation?
In economics, the term “inflation” refers to periods of time when a country’s currency decreases in value. This can impact a number of things. First is the price of goods and services. If you’ve wondered why a Big Mac cost 65 cents in 1970 but costs nearly $5 today, inflation is the reason why.
Another thing that’s affected by inflation is interest rates. A post on inflation and interest rates from AskMoney shows that they tend to trend in opposing ways. This means that if inflation is low, interest rates go up. Less people are able to borrow money, so products and services become cheaper to compensate.
However, inflation isn’t all bad. Investment assets like value stocks, real estate, and commodities can outperform during periods of high inflation. The Intercept adds that it can lessen the real value of debt, as well.
What’s the relationship between crypto and inflation?
Because crypto is both deregulated and decentralized, it’s not affected by factors like interest rates — and, theoretically, inflation. This should be something that helps crypto stand apart from other investment assets like stocks, bonds, and real estate.
For example, the demand and thus the value of Bitcoin can remain high even if inflation devalues the US dollar. However, the Bank of America argues that this isn’t the case, as crypto values can be volatile, resulting in wild swings from quarter to quarter.
Hedges against inflation should ideally have a high level of stability and thus be deemed a trustworthy investment. We mentioned that Bitcoin alone dropped $40,000 in value within 7 months, so crypto isn’t as good a hedge as it should be. Ultimately, this means that crypto can’t outpace inflation in the long term.
If crypto isn’t a good hedge, what is?
Bitcoin is an inflationary asset: its supply increases over time through crypto mining. Conversely, cryptocurrencies like Binance are deflationary. Their supplies decrease over time while demand stays the same. Unlike inflationary assets, they can keep up with inflation.
However, the stablecoin is the best crypto inflation hedge so far. Its value is tied to that of a fiat currency like the US dollar. But if fiat currencies are typically affected by inflation, what makes the stablecoin a good hedge?
Not all fiat currencies are prone to devaluation via inflation. These currencies are more stable, and you can invest in stablecoins associated with them as an inflation hedge. In fact, stablecoin purchases related to the Argentinian peso recently shot up for this precise reason.
Though crypto and inflation seem unrelated on the surface, we hope this article shows that they are linked, and proves useful if you are thinking of investing in crypto.