Cryptocurrency and Inflation: Is There a Connection?
Inflation can cause huge economic issues for many, especially investors. In recent years, inflation is an even larger concern. The COVID-19 pandemic created a surge in the inflation rate - rising it to 8.5% in the United States. There are many causes of inflation, and currencies all over the world are susceptible to it. The relationship between cryptocurrency and inflation, however, remains a contested topic.
Many crypto enthusiasts claim that crypto is resistant to inflation. With our extensive knowledge of cryptocurrency, we wanted to find a definite answer. Does inflation devalue cryptocurrency? We analyzed several real-life arguments for why or why not. In this article, we explain exactly how inflation impacts crypto.
Does Inflation Devalue Currency?
In general, inflation tends to devalue the currency. However, it’s also more complicated than that. Inflation is an increase in prices and the general costs of an economy. We can also define inflation as the decrease of a currency’s purchasing power. It occurs over a long period, though certain causes accelerate inflation.
Many economists agree that a little inflation is healthy. It stimulates the economy by keeping people at work and shopping. Too much inflation, though, spells disaster. This unmanageable increase in prices is hyperinflation. It most often occurs due to monetarism; when too much money enters the system and loses value.
Suggested reading: Hyperinflation on a Global Scale: Is Crypto the Answer?
Other causes of inflation include:
- Devaluation - the legal and deliberate reduction of a currency by the government. This is usually done to decrease the cost of exports and trade deficits.
- Loaning Through Government Bonds - a method of creating new money to stream into the market. In this case, the government borrows bonds from the Federal Reserve. This temporarily boosts buying power, but can also create a bigger fallout.
We can categorize inflation into three main types. They are:
Most workers support this type of inflation. As they demand higher wages to maintain their quality of life, prices also rise. This keeps people motivated at work and gives them the ability to spend more. One popular example of built-in inflation is a consistently higher minimum wage.
This inflation occurs when production costs increase. It also pushes the prices of goods and services to rise. This can cause a bottleneck of key commodities in the market.
This occurs after a shortage in commodities. It is described as ‘too much money chasing too few goods. The demand for them goes up, so the government releases a calculated supply of supplies and credit in the market. It satisfies the demand, raises prices, and leads to more consumer spending.
There are many examples of the severe impact inflation has on economies around the world. Venezuela suffers from some of the world’s worst hyperinflation. Its government distributed too much cash into the market, making prices go sky-high.
Both historically and currently, inflation devaluing currencies has been a major concern. However, cryptocurrency is not technically a currency, nor is it fiat. Cryptocurrencies run on a decentralized system. It isn’t controlled by a central authority like a country’s government.
Inflation may have a huge impact on trades and investments made in US dollars or the Renminbi (Chinese yuan). This impact may differ completely when using crypto to trade. Due to the nature of cryptocurrency, it certainly may act as a hedge against inflation.
Can Cryptocurrency Inflation Happen?
Experts haven’t agreed on how resistant cryptocurrency is to inflation. Some crypto experts argue that governments cannot influence crypto blockchains. Therefore, they can’t distribute too much crypto and devalue it. If inflation in a country does occur, crypto assets wouldn’t be directly affected. As crypto is a new concept, there’s not much data to prove cryptocurrency inflation can happen.
Some experts argue that inflation is beneficial to the digital asset space. With fiat currency losing value, many people invest in crypto to store value. Higher demand and more investments into a cryptocurrency boost its value.
However, crypto has its risks as well for value storage. Economists think that inflation will remain high into the coming years (2023 and onward). Cryptocurrencies like Bitcoin lost up to two-thirds of their original value as inflation also rose. This proves that inflation influences the cryptocurrency market.
USD inflation rate since 2021 (pictured below)
Historically, cryptocurrency shows extreme volatility. Investors classify crypto as either a commodity to trade (like gold) or a security to invest in (like stocks). Both of these types of values are sensitive to inflation pressures.
It’s important to keep in mind that not all cryptocurrencies are the same. Some crypto blockchains function differently from others. Cryptocurrencies can be the following three traits:
The supply of these cryptocurrencies will decrease over time. With a smaller supply, the value of the crypto should rise (or remain stable). Bitcoin uses this system. The blockchain halves the supply of new bitcoin about every four years in an event called ‘the halving’. The block reward of bitcoin also decreases over time. This system has worked well, as bitcoin has risen in price over the years.
In this case, the blockchain destroys old crypto and mints new coins or tokens based on certain conditions. This can happen with stablecoins, which are pegged to the value of a fiat currency. TerraUSD is a stablecoin on the Terra blockchain pegged to the United States dollar. If the value of USD were to depreciate, so would the value of TerraUSD.
When there is no supply cap on a cryptocurrency, it is infinite! Ethereum is a popular example. Developers use Ethereum’s blockchain to build new projects on, like NFTs, which keep it consistently in demand. Since it serves so many purposes, there is no need to impose a supply cap on its supply.
Cryptocurrency and inflation: is crypto a hedge?
Simply put, cryptocurrency has not yet proven itself to be an effective hedge against inflation. It’s still a relatively new investment type and one that is still worth considering to be a part of your portfolio. That being said, nothing in investing is guaranteed.
Buying crypto does not guarantee you a hedge against inflation. There are still misleading narratives out there in addition to scams and high risks. Hence, when buying or storing crypto you must choose a high-quality, reputable service provider.
YouHodler, a fully regulated FinTech service in Europe acts in its client's best interests. With decades worth of professional finance experience, YouHodler provides various features for your specific goals and risk tolerance.
For example, if you’re looking for a low-risk, easy way to generate yield on stablecoins or cryptocurrency to hedge against inflation, try YouHodler’s crypto interest feature. For those with an appetite for higher risk, with the ultimate goal to multiply their portfolio with the power of loans, Turbocharge or Multi HODL are the features for you.
Then, there is Dual Asset. A feature for both the conservative HODLer and the active crypto trader. This dual currency investment tool helps clients acquire more crypto or stablecoins depending on the outcome of their position and the state of the crypto market. It’s a great way to experiment with crypto market volatility and generate high yields in the process.
Best of all, this is possible without advanced crypto knowledge. Inflation is here to stay, but that doesn’t mean you need to exit the crypto market. Bull and bear markets are ripe with opportunity and YouHodler provides you with all the necessary tools to activate your crypto. So give it a try.