We know cryptocurrencies to be deflationary, but how does the inflation of the traditional financial market affect them? With inflation rates at an all time high around the world, will this affect Bitcoin, Ethereum and the rest of the crypto market? Let’s find out.
The Appeal Of Crypto
Cryptocurrencies are generally considered to be deflationary (if they have a fixed total supply). When Bitcoin was created, it was determined that there would only ever be 21 million BTC. Applying simple supply and demand economics and a mechanism which controls the release of new coins into circulation ensures that the price will increase in value, which has been the case to date.
Some people invest in crypto looking to make fast cash, while others are investing in the projects that the coins represent or the greater blockchain technology. Another reason some might invest in Bitcoin is as a hedge against inflation, with many calling it an inflation-resistant asset.
However, in recent weeks, the US dollar’s purchasing power has been creeping up on that of Bitcoin’s. So, what are the dynamics of the relationship between inflation and crypto?
Let’s First Explore Inflation
What is inflation? Inflation is when a currency loses its value over time. As the economy grows and goods become more expensive, the purchasing power of the currency weakens over time. When inflation increases, so too do interest rates.
In 2020 following global market dips as a result of the pandemic, fiat currencies’ value took a nosedive. In the US, the value dropped even further due to the government printing money to “help the economy.” Look to Venezuela, Turkey and Zimbabwe for the long term effects of printing money. By the end of 2020, the US dollar was significantly less powerful.
At the same time, the crypto markets were expanding. Bitcoin was engaged in a full bull run, leading the way for the rest of the markets. Institutional investment even began to grow as companies sought to move their reserves from the failing dollar into digital assets.
In May, the FED announced that interest rates were increasing. Due to the nature of the cryptocurrencies and their protection against inflation, many moved their money into Bitcoin and Ethereum, sending the prices rising. These increases fell short when the Terra network crashed.
Is Crypto A Hedge Against Inflation?
After reaching highs in November 2021, the price of Bitcoin and many other cryptocurrencies started to decrease. While the US dollar strengthened and investors took their money out of the crypto markets, the price went through a patch of volatile price movements further pushing the downtrend in prices. This challenged the narrative that crypto provided a hedge against inflation.
While cryptocurrencies are deflationary and decentralized, there is a lot of discussion over whether they actually provide a solid hedge against inflation. When the markets are doing well, they certainly provide a safe haven for funds, but when the trajectory changes, so too do their hedge abilities.
While markets remain in a bear trend, analysts are looking to see whether Bitcoin will manage to outperform traditional assets and other fiat currencies. Until then, the jury is still out over whether inflation affects Bitcoin and Ethereum.
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