What Rising Inflation Means for Digital Currencies

Nov 8, 2021 | Digital Finance, Foundations

After a year of governments printing money to combat economic problems caused by COVID-19, inflation fears are on the rise again. So you may wonder, is cryptocurrency a good inflation hedge? It turns out some investors are already using it as one.

Inflation Expectations Are Rising 

There are two primary drivers around the expectations of rising inflation. The first is the amount of money printed last year. The United States and other governments worldwide printed trillions of new dollars. This was to provide relief through stimulus payments to families and businesses. This money has to go somewhere. Now consumers are seeing inflated prices in everything from grocery staples to investable assets.  

The second driver is that The US Federal Reserve (Fed) has spent several decades trying to limit inflation. Its usual tactic is to raise interest rates — which have caused economic slowdowns and recessions of various degrees in the past. With a general fear of slowing the economy because it’s still recovering from the pandemic, the Fed is reluctant to increase interest rates.  

The Fed also takes a more long-term view by reviewing average inflation over several years instead of trying to meet specific inflation targets each year. Because inflation has been low over the past several years means there is more room for inflation to rise which the Fed could allow in the coming months. 

Investors Flee to Crypto During COVID-19 

Early in the pandemic, digital currency prices soared as investors poured in money. This is because of several factors. 

First, stocks and corporate bonds were plummeting. Investors feared that an economic slowdown would result in years of lost profits and put many companies out of business — and investors who were pulling money out of stocks and corporate bonds needed somewhere to move their money.  

Second, bond rates were already near zero or even in the negative. Bonds have long been viewed as a steady source of income and stability but in the current market, bonds no longer produce income. And they risk capital loss once governments start raising interest rates. So bonds weren’t an option to many investors. 

Finally, investors began to fear the value of a dollar. With governments printing money, rapid inflation felt like a near certainty. And low-interest rates combined with inflation means cash is guaranteed to lose purchasing power. Investors wanted to move to an investment that was detached from governmental monetary policy.  

Cryptocurrency became a solution to these challenges.  

Why Cryptocurrency Works as an Inflation Hedge 

An inflation hedge is an investment that is not tied to the value of a dollar. This is almost the definition of cryptocurrency. Even though it can be priced in dollars, it has independent value and movement. 

Think about the oldest inflation hedge — gold. Gold’s price almost always goes up with inflation, and it’s not just because investors think that gold is becoming more useful over time. It’s really because the gold itself has both a utilitarian value and a relatively stable value in trade. If you would trade two bars of silver for one bar of gold, that trade value doesn’t really change if the cash value of either side of that trade is $500 or $1,000.  

When a government inflates the money supply, it reduces how much that currencies can purchase but has no direct effect on the purchasing power of assets, which are considered to be a store of wealth, such as gold and perhaps now, cryptocurrencies. 

What holding an inflation hedge such as gold does is protect your cash. Cryptocurrency works the same way. If you have $500 in cash earning no interest during high inflation, you’re losing value every day. If you have $500 that you convert to cryptocurrency, its price will rise with inflation as the value of that US dollar falls, just like a gallon of milk might sell for $5 instead of $4. You would sell for the new price so that you’d have the same purchasing power as when you bought it. 

When a government prints more money it only affects the supply of their domestic currency. It has no direct effect on the value of a cryptocurrency which means that crypto may be a good store of wealth in times of currency inflation.

Stephanie Baxter, Head of Global Markets at Fabriik

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