Inflation, like many other financial attributes, has its own effect on the performance of cryptocurrencies like Bitcoin and Ether within the crypto market. Not only crypto market but stocks, commodities, and even forex regimes are affected intensely by the ups and downs these experience with regard to inflation.
To be able to better understand the effects of inflation on the crypto market and how it corresponds with multiple cryptocurrencies, it is first important to understand the basic concept of inflation.
What is Inflation?
Inflation is a systematic process entrenched too deeply into the present financial regime, which causes its potential currency to lose its value over time. This directly influences the price of the goods and makes them more expensive over time.
You might have noticed that in the past, you could maybe buy one dozen eggs for $2.00, but today the same quality and quantity of eggs cost that initial price thrice; what do you think has happened here? It is the inflation that has propelled the price of these goods to an ultimate high.
Role of Inflation in the Crypto Sector
Multiple promises were made when the first cryptocurrency, Bitcoin, was launched back in 2009; it represented a totally decentralized mode of finance that didn’t rely on a single element of control like with banks and other financial organizations across the world.
And it was instantly remarkable for various investors who value this sort of thing while looking for an investment opportunity.
Other than that, it was also promised that Bitcoin would not succumb to the devilish dawn of inflation like the dollar, euro, or even gold do over time, and this statement has retained its value after all these years as cryptocurrencies belong to such an asset class which only experience extremely low rates of inflation.
Bitcoin vs. US Dollar
To prove the earlier statement made about cryptocurrencies facing only a minimal rate of inflation, one need not look any further than the current price of Bitcoin.
When Bitcoin started trading in 2009, it was valued at mere cents; the market was so new and fashionable that investors at first were hesitant to invest in Bitcoin, and they didn’t want anything to do with it. But fast forward 11 years, and today Bitcoin is valued at approximately $20,000.
In between that time, the value of Bitcoin grew so intense that it achieved an all-time high of $67,000.
Whereas dollar, on the other hand, is losing its value and becoming weaker and weaker over time. This is one of the reasons why investment gurus out there regard Bitcoin as a hedge against the rising inflation of the fiat world.
One would think that if the all-time high value of Bitcoin was true $67,000, then how come it is now at a mere $20,000 price point?
Apart from inflation acting at its own course, the crypto market has to face extreme volatility, which slams the prices of assets down the hill.
Whereas the same is not true about other financial markets out there, volatility does impact all financial markets but not as intensely or ferociously as it does with the crypto market.
Limited Supply of Cryptocurrencies
It is the basic rule of economics that whenever something is in abundant supply, its value is going to be far less, and the same principle applies to inflation. When it comes to Fiat currencies such as the dollar, euro, or British pound, the regulatory oversight on all of these has the authority to print as much cash as they want.
Usually, there is a limit as to which they can print the cash, such as the total gold reserves that the country owns at the moment.
When it comes to a majority of cryptocurrencies, these have a fixed amount of tokens that can be minted; for example, Bitcoin has a limited token supply which means that people can’t just go about minting more and more Bitcoin.
They would have to operate within the present capacity of the Bitcoin tokens that the algorithm of Bitcoin Blockchain allows for.
This really makes things interesting from an inflation point of view, because the supply of Bitcoin tokens has been deemed limited; thus, inflation has little to no effect on this specific cryptocurrency.
There are only going to be 21 million Bitcoin tokens in the world, and not a single token is more than that. To make sure that these results can be achieved in real-time, every four years ‘halving’ of Bitcoin takes place, which essentially reduces the overall quantity of Bitcoin tokens that can be mined.
Importance of Inflation for Cryptocurrencies
As stated earlier, Fiat currencies have extremely high rates of inflation, which generally means that their value decreases over time, and thus they do not prove to be a very good hedge against inflation.
This increase in the inflation statistics of Fiat currency compels most investors to look into digital money for investment purposes.
You might think that the savings account that many people over the world use actually provide those investors with gracious returns, but that is not true at all.
For every increase in the overall percentage of dedicated savings accounts, the value of that particular currency is being lost in the mist. It is depreciating fast, and the increase in the quantity of the final cash count doesn’t necessarily mean that its value has increased as well.
That is why cryptocurrencies such as Bitcoin and Ether provide a more durable approach when it comes to generating handsome revenue for one’s investment. Whatever features these might be when it comes to the capacity of cryptocurrencies to resist inflation are not laid out in grave detail however following are some of the commemorative qualities of cryptocurrencies, such as Bitcoin, which allow them to become a qualitative hedge against inflation;
Zero State Oriented Manipulation
The Fiat financial system is always at the mercy of the government or state that it is presently serving.
Any bank or financial authority is under the regulatory network of the country in which that particular firm is providing its services which means that it would have to pay taxes, comply with the present regulatory framework of that specific country, and would be palpable to serious scrutiny that’s making it a vulnerability towards inflation.
Cryptocurrencies such as Bitcoin, on the other hand, can’t be manipulated in any potential way by governments of the world trying to force their policies onto it or adjusting the interest rate over these cryptocurrencies.
Apart from all this, the states or governments of the world can’t force Bitcoin, or any other cryptocurrency for that matter, to print or mint more tokens as all of this takes place in a decentralized fashion, which is why these cryptocurrencies are extremely resistant to government-induced inflation.
Bitcoin as a Strong Hedge Against Inflation
Many crypto analysts and gurus have already given Bitcoin the same standard as they would gold and other such precious metals, which lay the entire foundation of the centralized financial regime of the world.
Bitcoin can provide tremendous value, especially in uncertain times, because of the fact that its value will not be derived by the same standards as everything else being traded or offered on the open market.
The digital premise of the financial world has made it extremely easier for investors to just put their investment money into digital assets such as Bitcoin rather than having to go out of their way to buy gold or such other commodities which are required to be taken care of, stored and maintained on a consistent basis.
The same is not true for Bitcoin or any other cryptocurrency for that matter, and it can be bought or sold with a few simple clicks on one’s mobile device or computer; that is why it is a much preferable choice to solid commodities.
Scarcity Drives the Value of Cryptocurrencies
For any particular asset to act as a store of value or to provide a hedge against inflation, it is important that its availability is limited; and other words, it must be a scarce entity.
The forex currencies of the world are not scarce; whenever their particular governments or regions in which those particular currencies are active and used for trading feel the need, they just go out of their way to print more money. This does not increase the value of the asset but does the opposite and undermines it in a big way.
As for the cryptocurrencies such as Bitcoin and Ether, their availability is limited, and scarcity happens to be those magical ingredients that make them a perfect hedge against inflation.
As explained earlier in this guide article, Bitcoin will never exceed 21 million tokens, and when that particular number reaches, there will be no more minting of Bitcoin taking place.
At the time of writing, there are already 19 million Bitcoin tokens that are active and circling out there. The halving application towards the minting of Bitcoin will actually decrease the per block Bitcoin tokens given to miners as a reward, and in 2024 this value will be cut down from 6.25 Bitcoin tokens to only 3.125 Bitcoin tokens, and the same will happen eventually every four years until all the Bitcoin tokens which were designed to be minted have been mined.
You can always run into more gold or silver or platinum when you go about discovering further parts of the earth or digging deeper into oceans, or scavenging out in the desert, but the same is not true for Bitcoin or the majority of cryptocurrencies out there.
Their total amount is predetermined and is pegged into their individual blockchain protocol, which doesn’t allow for these settings to be tampered with or edited at a later date hence making these a bit more stable in the face of uncertainty and inflation.
It also means that there are few very specific markers of cryptocurrencies that could be studied more eloquently hence making it somewhat of a predictable investment body as opposed to gold or silver, whose value and market factors are going to change when there is more of it discovered at times.
But there will be no discovery for cryptocurrencies because their number is known beforehand.
Investors Want Certainty and Stability
This is a rather simple experiment; you do a sitting with any particular investor out there and ask them a simple question. Would they rather reap a consistent profit on their official investment or shoot for a big reward or return that might be a hit or miss?
They would instantly say that they want a consistent and stable profit on their original investment, so why not the big reward that might or might not come? Because it is not very stable or wise, even as opposed to a consistent profit that lands in their bank account on a monthly or yearly basis.
If you enclose the same psychology into cryptocurrencies, then you would find that these preach stability, as opposed to Fiat currencies, are liable to a plethora of different equations and factors that are governed by particular States and governments, which destabilize their momentum in the long run.
Sure it does not wipe away the volatility factor that is imminent with cryptocurrencies as opposed to earth metals such as gold or silver, but the investment and the reward that is delivered with respect to the investment made is extremely stable.
If you are an investor who has a surplus amount of money and they are comfortable taking a few risks, then you would do wonderfully in the crypto market as opposed to commodities or the forex market, or even the stocks market.
This is because all of these market segments have their value pegged to the dollar or some other fiat currency.
Does Inflation Affect Cryptocurrencies?
Inflation remains a necessary evil in the financial world designed to keep things from getting out of hand and to pace the element of ROI (return on investment). It means that inflation is not only active in the commodities, forex, or the fiat world but also in cryptocurrencies.
Bitcoin or any other cryptocurrency can experience inflation from time to time, and most of it has to do with the process of mining.
Whenever there is a production of new Bitcoin tokens, inflation does chime in and try to cut out the present value of that particular asset, but as every four years, the amount of Bitcoin tokens is reduced by half, so does the rate of inflation catering to Bitcoin.
It means that as the world approaches completing the 21 million Bitcoin token mark, inflation is being decreased at the same rate.
Many crypto experts believe that as the purchasing power of Bitcoin continues to grow over time as compared to Fiat currencies, the minimal percentage of inflation acting upon it annually doesn’t remain a major factor that should scare the investors away.
As long as people are buying Bitcoin and its amount is being decreased every four years, or so the inflation does not hold the same value or strength towards Bitcoin or any other cryptocurrency for that matter, whose token count is limited as opposed to the Fiat currencies that can be printed over and over again.
Stablecoins Offer Stability
Another element that should be considered here when trying to correctly measure the rate of inflation acting on Bitcoin or other cryptocurrencies is the fact that there are stablecoins as well among the category of cryptocurrencies that are not exactly the decentralized entities cryptocurrencies claim themselves to be.
Stablecoins have their value pegged into fiat currencies such as the dollar or euro, and in that particular sense, these behave exactly like a fiat currency that is being rooted and applied in a particular geographical area or a country.
But one of the most astonishing aspects of stablecoins is that their entire infrastructure and mode of operation are based on the decentralized principles of blockchain technology, so in their action, these are cryptocurrencies, but in their literal definition, these are just like fiat currencies operating on a blockchain network. So what is their benefit at the end of the day?
These are less prone to volatility as opposed to other cryptocurrencies that experience sudden and swift jolts of it. Many investors who want to experience lesser volatility and an agreeable amount of inflation would be more interested in investing their money into stablecoins as opposed to currencies that experience higher inflation and cryptocurrencies that experience a less amount of it.
Stablecoins provide investors with a measure of balance that they didn’t know existed between the crypto and Fiat world.
You can think of these stablecoins as a savings account in which your interest over the investment made is accumulated over time, any change in the value of the stablecoins is definitely going to change the measure of profit deposited into your savings account, but at the same time you’re going to experience less and less volatility, and for that, the investment into stablecoins is worth the shot.