Cryptocurrency and Inflation: What’s the Fuss About?
With rising inflation rates across the globe, many people are starting to ask what role cryptocurrencies could play in averting future price hikes. Some commentators – often on social media – argue the likes of bitcoin and ethereum are an inflation-proof alternative to traditional currencies and could therefore help curb price rises in the future. However, the reality behind cryptocurrency and inflation not so clear-cut.
In this post, we’ll look at both sides of the argument and the middle ground. First, let’s look at what inflation is.
What is inflation?
Inflation is the sustained increase in the cost of goods and services over time. Simply put, price rises cause the value of money to fall. For example, if the price of goods you buy every day goes up by 2% a year, your money is no longer worth the same amount as it was a year ago.
This means that if you’re trying to buy the same quantity of goods that you were able to do a year ago, you are effectively spending more to do it – even though you may have the same amount of money in the bank.
In normal times, low inflation levels of around 2% are manageable and often regarded as a healthy sign for the economy. When prices and salaries move up roughly the same rate, you would barely notice the effects of inflation.
However, as you will have no doubt noticed, inflation has skyrocketed across the globe. In the US, the rate is expected to peak at around 9%, while the picture in Europe is even bleaker. The UK is anticipating a peak of 13%; in Germany, it’s predicted to reach 6%; in Italy, it is forecast to hit a staggering 20%.
Causes of inflation
The huge costs inflicted by the pandemic and government spending to avert a simultaneous economic and health crisis. Government salary relief schemes, where companies could claim money to cover the cost of salaries when employees had to stay at home, cost billions of dollars. Add that to the cost of stockpiling medicines and medical equipment. To pay for this, central banks needed to print money – known as quantitive easing – which works in the short-term but ultimately devalues that particular currency.
This was compounded by supply chain issues, which drove up the price of goods and manufacturing. Unlocking the supply chain after unprecedented disruption and continued lockdowns in China has been a drawn-out process that will continue well into 2023.
On top of this, the war in Ukraine has further exacerbated the situation, weakening the economies of some of the EU’s largest member states – notably Germany and Italy.
Cryptocurrency and inflation
People often say that bitcoin is inflation-proof because it can’t be printed like fiat currency and therefore cannot be devalued in inflationary environments. Advocates of this argument also point out that the issuance of bitcoin, and other cryptocurrencies, are determined by code – not centralized bodies like the Federal Reserve. This prevents governments from simply printing money when it wants.
There’s also the fact the cap on cryptocurrencies means that the supply of each crypto is finite – theoretically, at least. The cap does reduce the chance of high inflation, but that’s only one component of a complex picture.
The idea that governments cannot influence the supply of cryptocurrencies lies at the very heart of the ethos of crypto purists. They see bitcoin as the digital equivalent of gold – an asset that cannot be inflated away or controlled by central authorities. However, this claim has come under fire in recent years as several prominent industry figures have argued that major firms have exercised significant influence over network development and acceptance.
The argument against crypto’s inflation resilience
For those of you who weren’t born yesterday, you’ll know that the crypto market experiences volatility. The price of cryptocurrencies is subject to sharp fluctuations and those swings can be extreme.
For instance, bitcoin reached an all-time high of over $68,000 in November 2021 but fell below $20,000 across June and July 2022. This represents a 350% drop in just seven months.
Those figures indicate that bitcoin isn’t immune to inflationary (or deflationary) pressures. Most other cryptocurrencies, aside from stablecoins, have displayed similar patterns.
And with the increasing involvement of governments worldwide, like the SEC identifying specific cryptos as Securities, these pressures are set to increase.
Cryptocurrency and Inflation: It’s Complex
As you might have suspected, there’s no definitive answer to this debate. The effects of high inflation are leading people to find alternative solutions. Cryptocurrencies can undoubtedly play a role, but it’s too early to say whether they can prove inflation-proof.
However, there’s an emerging consensus that crypto is on the cusp of market maturity. In the long-term, major cryptocurrencies like bitcoin and ethereum are likely to become less volatile and more stable investment assets. And although short-term price movements will continue to be challenging to predict, the appetite for crypto will likely grow in the coming years.
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