Crypto can act as protection against inflation, but not until it establishes its fundamentals and achieves mass adoption. In theory, Bitcoin (BTC) should hedge against inflation.
It’s easy to access, its supply is predictable, and central banks cannot arbitrarily manipulate it. However, investors aren’t treating it that way. Instead, the cryptocurrency market is mirroring the stock market.
Why is that? Let’s dive into what prevents cryptocurrencies from acting as a hedge against inflation and what needs to happen to make them a hedge in the future.
Crypto could be a hedge, but it comes with inconveniences. Cryptocurrencies present a unique solution, given their lack of a central governing bank. You can’t lose trust in something that doesn’t exist.
Its supply is finite, so it naturally appreciates. People using a blockchain with proof-of-stake protocols can access their funds anytime while continuously earning staking rewards on their current balance.
This means that the actual value of annual percentage yield is tied to the economic activity on the chain via its treasury and staking reward distribution mechanics.
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Those properties seem to address the cause of inflation in the traditional monetary systems, but some roadblocks remain. For starters, let’s examine the reasons why people invest in and hold cryptocurrencies.
Most cryptocurrency holders see the future potential of those technologies, meaning some of their value is not currently present. They are speculative investments. Bitcoin has achieved decentralization,
but its exuberantly high energy costs remain unaddressed, and most mining forces are still aggregated into a dozen mining pools. Ethereum has similar issues with energy consumption and mining pool centralization.
Ethereum also has a security problem. More than $1.2 billion has already been stolen on its blockchain this year. There’s also the issue of decentralized exchanges, or DEXs, which are currently not as fit for use as centralized exchanges.
The DEX with the highest transaction volume, Uniswap, offers inefficient pricing compared with a centralized exchange. A simple trade of $1 million in Tether (USDT) for USD Coin (USDC) would cost over $30,000 more in fees and slippage than executed on a centralized exchange.
These are technical problems that have solutions. Granted, these issues are being addressed. Several third-generation blockchains are tackling energy consumption and decentralization head-on. Privacy is improving.
Crypto holders are beginning to accept that their wallets will always be fully traceable, which will prove enticing to new users who have previously been hesitant over blockchain’s hyper transparency.
Projects seeking to merge traditional finance’s mathematical rigour with the native attributes of cryptocurrency are tackling the problem of DEX inefficiency.
Mass adoption and integration must happen before crypto can act as a bulwark against inflation. Crypto has characteristics of future value in an ecosystem that is currently struggling to establish its fundamentals.
The crypto economy is still waiting for applications that will take full advantage of decentralization without sacrificing the quality and experience, which is especially important for widespread adoption.
A payment system where each transaction costs $5 and the exchanged value is regularly lost will remain unfeasible. Until the top cryptocurrencies can be used efficiently for real-world payments and decentralized applications provide a similar level of utility as centralized systems,
crypto will continue to be treated as a growth stock. A lack of trust causes inflation — something crypto still needs. Inflation isn’t caused by just printing more money, which is to say that the presence of an asset doesn’t automatically cause its value to go down.
Between September 2008 and November 2008, billions of U.S. dollars in circulation tripled, yet inflation went down. Inflation has much more to do with public distrust of the central monetary system. This lack of confidence — combined with corporate price gouging,
the upheaval caused by pandemic relief packages and significant supply chain disruptions, have landed us in the current crisis. The giant money print of 2021 didn’t cause inflation but magnified it. Concerning presence, the supply of funds alone is not an overly significant issue for a store-of-value currency.
What is stored is not necessarily part of the circulating supply. Gold, for example, exists in large volumes in jewellery, bullion and so on, but in much smaller books on the commodity market. A market that considered all the mined gold on earth would have a different price.
Because this jewellery and bullion are not traded on the market, they do not affect the supply-and-demand curve. The same applies to currency.
Inflation results from a loss of trust that an asset can store its value over a long period. Most goods in this world are finite, so every party aware of the raised supply but unsure of the monetary policy will automatically factor it into their prices.
Inflation becomes a self-fulfilling prophecy. Crypto as an inflation hedge is possible, but not in the current climate Cryptocurrencies fail as an inflation hedge during times of high volatility and market uncertainty.
That said, they generally excel in steady growth environments where they easily outperform the market and where the relatively small market capitalization compared with fiat currencies plays in their favour as a growth stock.
Current solutions to the usability problem aren’t sustainable due to their speculation-based nature and low transaction volumes. The fall of financially unsound blockchains affects the entire ecosystem,
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This means that potential long-term solutions keep being derailed by scammers. The more responsible and diligent the crypto community becomes, the more every sound protocol will benefit, and crypto will become a natural hedge against inflation.
Because cryptocurrencies currently follow growth stock patterns, they act as a good hedge against inflation during periods of stable growth but fail during times of financial crisis. As cryptocurrencies evolve, they’ll also become an effective bulwark during these downturns.
These days, it’s prudent to err on the side of caution when it comes to crypto investing during periods of market turmoil, and it would be unwise to use crypto as the only tool for shoring up investments against inflation.
But this will shift as blockchain protocols mature, and we’ll see an increase in the adoption and stability of cryptocurrencies as inflation hedges. The tools are already in place. - cointelegraph
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