Crypto enthusiasts vouch for their preferred money as being a fortress against inflation. Before Bitcoin, people only understood that money was issued by the government and that the Reserve or Central Bank controlled its supply and interest rates.
Therefore, when Bitcoin introduced a controlled and encoded supply mechanism, it was a whole new technique to limit the quantity of money. It brought with it the almost legendary ability of cryptocurrencies to protect against inflation.
Yes, crypto investments can accomplish this goal, but it’s not an easy task. Cryptocurrencies’ pronounced price fluctuations complicate their usually straightforward sales pitches.
This installment will examine one of the most contentious cryptocurrency theories and what it means for protecting your savings from inescapable inflation.
Why Is It Said That Investing In Crypto Is An Inflation Hedge?
This theory is based on the fact that the original cryptocurrency, Bitcoin, has a fixed supply limit of 21 million units. As a result, there will only ever be 21 million coins in circulation, making Bitcoin increasingly rare.
One of the most valuable features of Bitcoin is just that characteristic. Bitcoin’s supply is unchanged while the Fed and other central banks across the world continue to print new money and weaken purchasing power. The supply mechanics of bitcoin prevent this from happening, making it “deflationary” in that sense. Because of this, Bitcoin has come to be known as “digital gold.”
This viewpoint has only grown more popular as a result of praise for BTC as a store of value from prominent organisations like Goldman Sachs. After major corporations like Microstrategy, MassMutual, and Tesla added BTC to their balance sheets, it has gained even more support.
However, there are valid concerns against using cryptocurrency as an inflation hedge.
Why Crypto Is Not a Good Inflation Hedge?
Some business analysts are nearly always waiting with bated breath to say, “I told you so,” when it comes to cryptocurrency and inflation. This was the situation during the Covid-related inflation, which the conflict between Russia and Ukraine has only exacerbated.
The consensus throughout has been that cryptocurrency investments, which are meant to be above the fray (of declining fiat currencies and traditional assets), have fallen short of expectations.
Even the argument that cryptocurrencies are “digital gold” doesn’t seem to stand up very well, as at the time of writing, real gold is outperforming Bitcoin. The peak of cryptocurrency occurred around this time last year, when NFTs exploded, conventional institutional investors entered the market, and the original cryptocurrency reached its all-time high of $68,000. Fast forward to today, and the price of BTC has fallen by an astounding 60% while the price of gold has only fallen by 5%.
The fact that the cryptocurrency market seems to be acting like traditional stocks in terms of market behaviour is not helpful. The issue then arises: Isn’t cryptocurrency a peculiar asset class, with distinctive market movements? Considering that it moves in lockstep with stocks, how can it be deflationary?
In contrast, consider the long-term value.
Even now, when things are dire and there is “blood on the streets,” cryptocurrency has shown to be a successful hedge against inflation. There is always a traditional currency doing worse elsewhere, and November 2022 ranks as one of Bitcoin’s “worst” moments. However, there are those for whom BTC is a respite.x
Additionally, even though cryptocurrencies are currently strongly outperforming gold, the king of crypto and other well-known cryptocurrencies have regularly displayed gold dust over the long run. Over the past five years, Bitcoin has increased by more than 400%, compared to the precious metal’s meagre 38% growth. Although gold may be moving in a more sensible direction, over the long run, it cannot compete with cryptocurrencies.
The decision to hedge against inflation is yours.
The decision to use cryptocurrency as a good inflation hedge ultimately depends on the individual. Despite the fact that we are all a part of the financial revolution, our expectations and experiences vary. For instance, someone in Venezuela or Zimbabwe, where hyperinflation has wreaked havoc, would use cryptocurrency to obtain more purchasing power.
Some people might invest their money in cryptocurrencies, which they then HODL. The term “hold on for dear life” (HODL) in the context of cryptocurrencies refers to an investment strategy that enables users to “ride through the exciting fluctuations of the crypto market” without giving up. For long-term investors with “diamond hands,” the HODL technique has proven profitable.
HODLing takes advantage of the cryptocurrency market’s well-known volatility. For instance, Bitcoin may drop below the zero line only to overnight soar to record highs. When a currency behaves in the latter way, HODLers are typically prepared to profit greatly.
For instance, Bitcoin surged over 7,000% from $15 in January 2013 to as high as $1,100 in December. Additionally, in December 2017 and December 2021, it reached record highs.
By investing your money in a currency that doesn’t follow the norms of the financial establishment, HODLing is a strategy for hedging against inflation and preserving wealth.
Your money in Bitcoin is protected from devaluation regardless of the reason of inflation, including geopolitical difficulties, the money printer going brrrrr, or demand exceeding supply (at least in terms of coin issuance).
Using DeFi to Hedge Against Inflation
Cryptocurrency is an effective inflation hedge due to many factors in addition to its speculative nature. Decentralized finance (DeFi), the idea that anybody, wherever with internet connectivity should have access to financial services, has emerged in this field. DeFi’s underlying idea is that, unlike banks and other traditional financial institutions, you don’t need to have excellent credit or an ID to access services.
These and other things are possible with Defi:
- Stake cryptocurrency and profit from yield farming
- In order to engage in arbitrage and profit from it, borrow money at fair interest rates.
- Purchasing Defi stocks
Traditional financial instruments are infamous for providing small returns, and inflation further depletes their value. Defi additionally provides decent rates that are resistant to inflation.
Yes, there is still a case to be made that cryptocurrency investments can serve as a good inflation hedge if we consider Defi and its long-term prospects.