Can Cryptocurrency Protect Against Inflation?

Can cryptocurrency protect against inflation? Since all investors need to be concerned about the chances of inflation and protect their investments from the effects of it in the long term, you, especially if you are a crypto investor, should know a thing or two about it as well.

Gold has been the traditional asset that is considered to be the strongest hedge against inflation.

It is due to the limited supply of it which keeps its circulation steady over time.

This means that it has an opposite relation with inflation where the value of gold increases when the inflation increases and the buying power of the US dollar tends to fall.

Unfortunately, gold seems to have underperformed in this aspect when inflation has increased over the past couple of years.

The price of it has decreased notably when the cost of everything from gas to housing has increased.

Fortunately, the price of crypto, especially Bitcoin, has not.

As inflation soared higher and higher all over the world, the price of Bitcoin continued to rise.

This makes it a much more effective hedge against inflation than gold.

Can Cryptocurrency Protect Against Inflation?

Can Cryptocurrency Protect Against Inflation

People often consider cryptocurrencies to be a good hedge against inflation, but whether it really is can raise a debate.

Still, people turn towards it when inflation starts to soar considering it to be the modern ‘digital gold’ due to its huge potential.

The most significant difference between cryptocurrencies and other currencies is that they all come with a limited or finite supply.

This, theoretically, helps them to retain their value over time and prevent inflation.

For example, the Bitcoin tokens have a cap of 21 million only.

With the rate at which it is increasing and circulating in the market, it can be estimated that it will reach that mark sometime around the year 2140.

If you consider other inflation hedges you will see that crypto, especially Bitcoin, is entirely different from them.

The value of the crypto coin is primarily based on the willingness of the other people entirely in holding it.

However, with all that said, you should have a clear understanding of its inflation hedge potential in the long term before you consider investing in it.

There are several factors that you need to consider for that matter since these can affect its potential in the long run.

The Potential Reasons

As said earlier, how well crypto assets can protect your investments will depend on a few specific factors.

One such factor is the ‘All In’ buy alert.

This happens sometimes, especially when the price of a particular crypto coin, for example, Bitcoin, reaches new heights, and at the same time inflation increases, both at record rates.

Ideally, the value of the digital assets is not linked directly with any other asset.

This means that its value is unaffected by the changes in the consumer prices of other assets such as real estate, oil, and any other profit-earning business.

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Even if there is a probable inflation, this does not mean that the two are necessarily linked.

Moreover, crypto coins are not directly linked with any economy or currency and it is not controlled by a group of stakeholders or companies.

Even then, cryptocurrencies have a high demand all over the world.

During high inflation times, people need to take on higher risks in order to offset the effects of the continual fall in the prices of assets.

In such situations, even an annual return on investment of 7% to 8% on the S&P 500 may be just a tad higher in comparison to the existing inflation rate.

This is in spite of the fact that the stock markets possibly offer the best risk-reward profile.

The most significant downside of high returns is that the current valuation may be much higher than the valuations of the years past.

This is why people need to shift their focus and look for investment avenues outside the stocks, even if it is at higher valuations.

One of the best crypto options to invest outside equities is Bitcoin.

This is because it is a crypto that circumvents most of the economic as well as political risks that are typically involved in stock investment.

Apart from the fact that Bitcoin has a predetermined supply of 21 million coins, of which 19 million coins have already been mined, it is also considered to be a store of value that is:

  • Easily transferable
  • More durable like gold
  • Effortlessly interchangeable and
  • Pretty secure.

Moreover, unlike gold, cryptocurrencies are decentralized and therefore are not controlled by the sovereign nations of the world.

Anyone can store and protect their crypto coins much more easily than gold anywhere in the world.

The supporting features of cryptocurrencies also make it a good inflation hedge, in spite of the fact that these are just ‘fake’ currencies.

One such feature is the blockchain technology which has several different practical use cases.

It is a better means of exchange that comes with no maintenance or storage issues like gold.

This is also the most lucrative asset on earth now which not only hedges your investment but also helps in creating wealth for generations to come due to its inherent features such as:

  • Its durability
  • Its divisibility in smaller denominations
  • It is hard to counterfeit and duplicate and
  • It is recognizable and does not need to be tested for purity.

No doubt, in this modern digital world, the value of cryptocurrencies is growing exponentially and much higher than other assets.

This has helped it to gain institutional support from both large companies and traditional investors.

Understanding the Pattern

In order to understand the pattern, you will first need to understand how well cryptocurrencies will perform over the long run.

Though Bitcoin has shown its phenomenal potential in the recent month, it does not automatically translate to all other types of crypto coins and make a good enough hedge against inflation.

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Remember, you are to think about decades here and not just a few years.

This is difficult because crypto coins came into existence in 2009 which gives you a very, very short period to consider in comparison to the gold that has been used as a valuable asset for centuries.

With such a short track record, it is very difficult to predict whether or not a particular crypto coin will retain the same or gain higher value over the years.

Moreover, a lot of people are still skeptical about cryptocurrencies and do not believe in their potential to be an inflation hedge.

They strongly, if not wrongly, believe that it will not remain valuable over the long term.

Yes, the crypto market is extremely volatile and the price changes may affect its potential as an inflation hedge but there are several other good reasons to believe it is a good investment for the long term.

Here comes the pattern that you need to analyze and understand.

According to some eminent economists, a revival of inflation is highly unlikely due to the conflicting economic trends which give rise to the deflation debate. The different factors they point out regarding this include:

  • Excess supply
  • Depressed consumption
  • Demographics shift
  • Impact of technology
  • Weak labor market and
  • Low velocity of money.

However, the stock market proves that inflation is a real occurrence.

In fact, the inflation expectations calculated based on the five-year breakeven rate of the US Treasury and Treasury Inflation-Protected Securities shows a five-year high.

This has resulted in a steep rise in the yield curve which is an indication of higher interest rates expected in the future.

This is because the central banks will have to find ways to tackle the inflation issues looming at large.

This will eventually cause damage to the debt-laden economies.

‘Good’ inflation, which is a result of low unemployment and economic growth, narrows the gap between demand and supply.

This results in more investments.

On the other hand, ‘Runaway’ inflation can result in a complete breakdown in the social order, worsen poverty, heighten uncertainty, and demolish trust in institutions.

This not only happens after the war but also today as you can see in countries like Zimbabwe, Venezuela, Argentina, and Lebanon to name just a few.

However, this does not really matter for Cryptocurrencies, Bitcoin in particular, due to the fact that its supply is not affected by the prices and its comparative attractiveness when yields are low in reality.

In an underdeveloped economy, it can act as a hedge for:

  • Broken payment systems due to corruption
  • Unstable governments closing bank accounts
  • Police states seizing the private wealth
  • Cyberattack threats in digital payment systems
  • Export devaluations and
  • Paranoid leaders wishing to disenfranchise opponents.

This will not only prevent more inflation but will also protect against social disruption or political instability.

In addition to that, it will also act as a protection against dollar debasement due to loss of trust, which may look gentler but is in fact quite insidious.

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And, since crypto trading is mostly denominated in dollars, the BTC/USD ratio will always move towards North because the value of Bitcoin will not fall with the dollar since it is not related to the economy.

Therefore, it can be safely said that Bitcoin investment is not only a good hedge against the macroeconomic ills but it will also provide a counterweight against the unexpected evils that are in the making.

The ‘crazy’ Thesis

This is a theory that highlights one more hidden potential of cryptocurrencies to make them a good investment asset.

The digital asset is unlike any other asset and the market runs on technology.

It is non-programmatic, decentralized, and fragmented and is maintained by the miners, validators, and developers.

They are spread across several networks and geographies, and, on the whole, this system does not relate to any standard form of economic thinking.

It is this ‘crazy’ modus operandi of the crypto market that makes it perfect for a world that has now gone to MMT and Keynesian economics from traditional monetary policy.

In this process, no one trusts each other and therefore the participants are more open to newer recipes rather than the traditional ones.

And for all these, investing in crypto tokens, especially in Bitcoin, will not only diversify your investment portfolio but will also prove to be much more than just a new recipe.

Your portfolio will be safe and well protected against inflation and be ready to take on the brave new world of finance much more confidently where old ideas are less than welcome and new ideas are yet to take root.

It will be ready to adapt to the economies and politics that can get pretty weird at times.

It will be your best option to try the untested ideas that are not tied to macroeconomic features or to the past assumptions.

In short, it will be your proven hedge against ‘crazy’ economic conditions that may affect both your financial health as well as physical and mental well-being.

Therefore, consider investing in cryptocurrencies today so that you are prepared for the possibilities of inflation well in advance and be responsible enough to prevent the chances of ending up incurring losses that are prohibitively expensive.

Conclusion

To conclude, it can be said that cryptocurrencies are a good inflation hedge but nothing can be said for certain. It is quite promising an investment right now, but will it fare well over time is best left to time itself.