What is inflation? Is Cryptocurrency Safe From It?

2022-07-22 17:03:35

Inflation means an increased cost of living. Crypto is not safe from inflation, but it withstands it.

## What is inflation?

According to the Federal Reserve, Central Bank of America; Inflation is an increase in the prices of goods and services. The rising price trend doesn’t specify certain types of products; it refers to the overall price jump for commodities in the economy.

Inflation drops the value of the currency that leads to a decline in the buying power of people. However, it has opposite effects on some tangible assets. For instance, the value of land or property rises.

Let’s Take an Example to Explain Inflation:

Bob purchases ten (10) items of groceries for \$100 from Walmart. After one year, Bob returns to the store to get the same stuff, but this time, he purchases those products for \$105. Bob experiences a 5% increase in the inflation rate. He paid \$5 extra to get the goods that previously cost \$100 a year ago.

Under this situation, governments print more dollars for the limited available amount of resources.

Inflation leads to higher prices, lowers the value of dollars, and declines purchasing power.

Many countries, including the United States, prefer to adjust the inflation rate between 2%-3% annually.

## Inflation vs. Deflation: What's the Difference?

Inflation is the general increase in prices for stuff in the country. In contrast, deflation is the decrease of those prices.

Let’s take an example of the difference between the two financial situations.

Inflation – Rise in the General Level of Prices

When goods and services are in high demand and consumers are ready to pay more for desirable items. Manufacturers increase prices for goods, inflation arises.

Deflation – Decline in the General Level of Prices

Alternatively, when many products and services are available in the market, but you don’t have enough dollars to purchase them.

For example, An iPhone has become very popular, and its competitors copy similar features and designs. They produce several similar products. Now, they have more goods than they sell. Companies drop the price of cell phones to sell them and lay off many employees to cut down the costs. It leads to unemployment. People have little money to buy items, and the process continues.

Credit providers decrease their offers. People don’t get access to loans to buy items. The production of goods increases and leads to the state of more deflation in an economy.

The Central Banks keep a vigilant eye to maintain a balance between inflation and deflation by conducting central monetary policy and adjusting the interest rates responding to the price changes for goods and services.

## Under Inflation: Fiat Money Vs. Cryptocurrency

Fiat currency is the most accepted and widely used in the world. Governments around the world print fiat currencies like dollar, pound, euro, Japanese yen, etc. They determine the value of fiat currency that is subject to inflation. In the worst economic situations, regulatory bodies inject more money into the economy; it causes hyperinflation and reduces the value of banknotes.

Fiat currency becomes worthless if the government prints too much money. For instance, After World War I defeat, Germany printed banknotes in bulk quantity to pay her debts. \$1 was equivalent to 4,210,500,000,000 German Marks in November 1923. The country experienced hyperinflation.

On the other hand, Cryptocurrency is a digital form of currency. It emerged on the decentralized electronic ledger, a blockchain that is not in control of the government. The supply and demand for digital assets determine the value of cryptocurrency. Bitcoin works on a deflationary model. The quantity of Bitcoin reduces to half after every four years, and the rewards of mining too.

The most inspiring feature of cryptocurrency is the controlled issuance of coins that restricts inflation.

## Cryptocurrency and Inflation

The growing interest in cryptocurrencies introduces new relationships with existing economic systems. But there are many questions such as is crypto also affected by inflation, or alternatively, can it be used to maintain financial stability in difficult times?

### Bitcoin Is A Reliable Store Of Value that Hedge Against Inflation

Bitcoin is the first digital currency, and the first financial application built on a decentralized blockchain. Bitcoin repels inflation because the maximum supply of Bitcoin will never exceed over 21 million, and each after four years, the amount of Bitcoin is reduced to half. This factor contributes more resistance to inflation than US dollars or any other fiat currencies. Bitcoin reputes as a popular store of value. It launched on January 03, 2009, with its price value hovering below \$1 that surged over \$64,000, with a market capitalization of \$1.18 trillion, as of April 13, 2021. Bitcoin recorded unprecedented gains in price value.

### Is Crypto Subject to Inflation?

Yes, it is. Cryptocurrency is a highly volatile market. The crypto market recorded substantial gains in one moment, but it reversed all its profits in the second moment and then it regained price value after some time. But, Bitcoin resists inflation with a potent image and gives high returns on investment. It has outperformed all other asset classes.

### Bitcoin Over Time

Charlie Bilello, Chief Executive Officer of Compound Capital Advisor, claimed in his tweet on March 13, 2021, that “Bitcoin is the best performing asset of the decade”.

He compared Bitcoin returns with 17 other asset classes during 2011-2021. Bitcoin secured the first rank and produced 230% annualized, approximately ten times more than Nasdaq 100, second to Bitcoin in the list of 17 assets classes. The US dollar recorded 0.5% annualized returns, ranked at 15th position out of 17 best performing asset classes.

### Is Crypto Safe From Inflation?

No. Crypto is experiencing inflation. The Bitcoin model withstands inflation, but not all cryptocurrencies operate on the same model. For instance, stablecoins are pegged to fiat currencies like dollars, euros, and more. When fiat currency loses its value, it affects the value of stablecoins.

One convincing argument is that Bitcoin is not a haven for investors all time. Frequently, it lost its value. In December 2017, the price of Bitcoin hovered around \$20,000, but after two months it dropped to around \$6,000, it slumped 70%. Similarly, on April 14, 2021, Bitcoin price soared around \$64,455 that sharply fell to \$33,000 as of May 24, 2021, estimating -% reversal in price value.

### Why Is Inflation Important for Crypto?

Inflation directly affects the crypto market. Let's learn how.

#### People Invest More in Crypto

When the inflation rate rises, the value of money declines. It swallows the investment in dollars or other fiat currencies. Alternatively, people prefer to invest in cryptocurrencies. The features of cryptocurrencies, especially Bitcoins, are designed to resist inflation.

#### Cryptocurrency Act as a Veritable Store of Value

One of the most promising features of cryptocurrency is scarcity. Scarcity means currency is in short supply. Bitcoin gained a considerable increase in value under economic crises at the start of the Covid-19 when the value of stocks, gold, or oil fell sharply.

The flexible issuance of Bitcoin at a decreasing rate maintains the demand for bitcoin and keeps the price stable.

#### Non-Intervention of Government in Cryptocurrency

The government manipulates interest rates or prints more money to achieve monetary targets in extreme inflation situations. This is the opposite case in cryptocurrency. People trust digital currency rather than a fiat currency in times of emergency when inflation increases.

The world witnessed that even in the worst Covid pandemic situation, the price of Bitcoins surged abruptly and set new astonishing records.

### What Effects Would a Widely Adopted Cryptocurrency Have On Inflation?

In April 2021, the U.S Consumer Price Inflation rose 4.2% from the last year, as reported by CNBC. It was recorded as the biggest gain since September 2008. The Consumer prices further increased 5.4% from the previous year. The Federal Reserve flooded dollars into the economy that geared up inflation. On June 10, 2021, Forbes reported that M2 money was \$20.11 trillion in April that makes up 30% more since Jan. 2020. Besides this, the Covid pandemic situation downsized operational activities that lead to increased production costs.

Inflation expanded and devalued money. Using crypto has some notable effects on Inflation.

#### Excess Use of Cryptocurrencies Lift Pressure on Fiat Money

The increasing use of cryptocurrencies lifts pressure on banknotes or coins, which is the only accepted medium of exchange in the markets worldwide. Using cryptocurrency can reduce high bank charges on transferring remittances that add up inflation.

#### Cryptocurrency Can Hedge Against Inflation and Deflation

Ken Rogoff, an economist at Harvard University, describing the benefits of a cashless society, he claimed that the withdrawals of money from ATMs add up maintenance costs, so banks pass these costs and transaction costs to the customers. This does not happen with the use of cryptocurrency. People don’t need to pay a maintenance fee to use crypto wallets as bank charges.

Besides this, in extreme economic downturn conditions, people could take cash out of their bank accounts. To combat this situation, the bank will adopt a policy of negative interest rates that contributes to deflation. However, Cryptocurrency is highly volatile. Despite it, people store their Bitcoin in their wallets for a longer time to serve as a good store of value as compared to paper currency.

In this situation, people flocked towards cryptocurrencies that act as a good hedge against inflation.

#### Cryptocurrency Is Immune to Monetary Measures

Cryptocurrency is not prone to monetary measures of the government that cause inflation with the printing of more money. In a pandemic situation, Bitcoin was tested as a haven for investors to hedge against inflation.

## Summary

In a state of extreme inflation, societies begin to collapse at a rapid pace. In such situations, many governments begin to print more money, and by doing so contributing to the loss of value of their currency and thereby creating a larger cycle of poverty.

The good news is, it seems that the situation can be controlled to some extent by the wider use of cryptocurrencies, especially Bitcoin.

It can now simply be said that the fate and future of the world economy and of digital currencies are intertwined.

How will they affect each other? The answer to this question is not visible to us yet, we will just have to just wait and see what the future of crypto holds for us.

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