With inflation reaching new heights, people are drawn to anything they can rush into for inflation protection.
Despite arguments to the contrary, cryptocurrency is often considered an inflation-resistant asset, and proponents often present it as an asset class that is uncorrelated with real-world assets. But things get complicated quickly when you learn that cryptocurrencies are unique and some are inflationary by design.
What is Inflation?
Inflation is an economic term that refers to periods when prices increase over time. Often this is because a currency is devaluing – when a unit of the same currency buys you less stuff than before. If you watch a documentary from the 80s and see someone selling a hamburger for 50 cents, while that same joint charges you $10, that’s inflation in action.
You may have realized the pinch of inflation when prices rise faster than your wages. You’re worse off if your $50,000 paycheck buys you 10% fewer goods and services than the year before. But if your employer raises your salary to $55,000, you won’t have to change your spending habits and you won’t feel the effects of inflation.
Economists believe that a little inflation is helpful in getting people to buy, thereby stimulating the economy. But in times of economic crisis, like the coronavirus pandemic, inflation can spin out of control.
Economists disagree on the causes of the current surge in inflation – the worst in decades – which measures around 8.5% in the United States. Some people are pointing the finger at the Federal Reserve for printing too much money, which in turn has been used to stimulate the economy and manage the pandemic.
Others say the Fed isn’t entirely to blame — supply shortages caused by the lockdowns were the main problem.
Crypto proponents believe that allowing central bankers to influence the economy through monetary policies, namely quantitative easing, leads to disaster. Massive money printing by the central banks of Venezuela, Turkey and Zimbabwe has ruined their respective economies.
Crypto advocates often say that cryptocurrencies like bitcoin (BTC) resist the incompetence of central bankers and governments because they are decentralized and cannot be closed.
Another reason is that the issuance of bitcoins is determined by a code – unlike the Fed, a central bank cannot mint as many bitcoins as it wants.
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As more bitcoins come into circulation over time, the rate at which new bitcoins are issued to miners is determined by the bitcoin protocol. The supply is capped and the supply of new coins is expected to run out around the year 2140. And unlike central banks, whose economists must react to market events, the Bitcoin blockchain runs like clockwork.
Every four years or so, the protocol halves the issuance of new bitcoins – the phenomenon is known as “halving”.
Bitcoin’s fixed supply has led some fans to consider it “digital gold” – a reference to the yellow metal, another beloved inflation-resistant asset. So-called stores of value assets stand the test of time because they are uncorrelated with other assets and are resistant to entities that interfere with the market. But are cryptocurrencies like bitcoin really an inflation hedge?
The Argument That Bitcoin Is An Inflation Resistant Asset
As the US dollar fell, bitcoin rose well above its value, rewarding early investors. But cryptocurrency is highly volatile: talk to recent investors who lost money when bitcoin crashed, and they might tell you that their investment didn’t outpace short-term inflation.
Over the past few years, bitcoin has followed the US stock market, which performs well when the economy is buoyant and stutters when spending declines, such as in times of high inflation. When inflation hit 40-year highs in December 2021, bitcoin fell. Whether bitcoin is a long-term inflation hedge without the benefit of hindsight is difficult to answer.
However, not all cryptocurrencies work like bitcoin. Some cryptocurrencies are deflationary – meaning supply decreases over time, designed to increase the value of the coin over time (if demand remains the same).
And some tokens, like non-fungible tokens (NFTs), are one of a kind – like a work of art, their value depends on how unique they are.
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