Is Bitcoin a new way to combat inflation? It was designed to weather recessions and economic unrest.
Bitcoin (BTC) is frequently promoted as a hedge against inflation, assuming that fiat money will eventually lose value due to central bank money printing. Bitcoin, on the other hand, has a fixed supply of 21 million coins. The limited upper limit gives Bitcoin an advantage over inflation. But, is Bitcoin immune to inflation?
During the COVID-19 pandemic, many countries printed more money to meet stimulus needs for their citizens, causing the value of money to fall. According to McKinsey Global, governments around the world have pledged $10 trillion by June 2020 to mitigate the economic damage caused by the global crisis.
As the value of fiat money fell, the value of scarce assets such as stocks, real estate, shares, and Bitcoin rose. Despite widespread unemployment and economic unrest around the world, the value of these assets has steadily increased. Traditional investors saw Bitcoin's potential as an inflation hedge, resulting in a historic price run that saw the decentralized digital currency gain more than 250 percent.
What is inflation?
Inflation is generally defined by currency depreciation and an increase in the price of consumer goods. Cryptocurrencies, such as Bitcoin, generally have low inflation rates due to their limited supply.
Inflation is typically defined as a persistent rise in the prices of goods and services in an economy. It also corresponds to the economy's currency losing purchasing power, which means that as inflation continues, it takes more and more units of currency to buy the same amount of goods and services.
Inflation affects all goods and services, including utilities, automobiles, food, health care, and housing. Inflationary pressures in an economy have an impact on both individual consumers and businesses because it reduces the purchasing power of money. In short, inflation reduces a consumer's purchasing power, diminishes the value of savings, and delays retirement. In order to respond effectively, central banks around the world monitor inflation. The Federal Reserve of the United States, for example, has a 2% inflation target. If inflation rates exceed the intended target, the system adjusts its monetary policy to combat inflation.
Is inflation here to stay?
Inflation has recently been more of a persistent than a transitory phenomenon. Inflation rates are steadily rising around the world, owing largely to the global response to the pandemic.
While high inflation rates may eventually subside, Yahoo believes that inflation is here to stay for three reasons:
- Labor market supply and demand imbalances
- Real estate prices are rising.
- Entry prices are expected to rise as well.
Is inflation good or bad for an economy?
Inflation reduces the purchasing power of a currency. Is this to say that inflation is bad? No, not always. Most economists believe that moderate inflation can be beneficial to an economy. In what way?
Consumer spending is driven by a low inflation rate. This is critical for any economy to grow, and it is also why the US Federal Reserve targets a 2% inflation rate in order to keep prices stable.
Inflation rates should be stable and moderate in a healthy economy. Economic growth is characterized by increased consumer and business spending on goods and services, as well as demand that exceeds supply. When demand exceeds supply, producers raise prices, causing inflation. In this context, inflation can be viewed positively.
However, any price increase or decrease that occurs too quickly is generally not a good sign. Consumers anticipate further price increases as a result of a rapid increase in prices. Consumers may then resort to stockpiling or buying more goods and services now in anticipation of future price increases. This behavior raises demand even more, forcing producers to raise prices. This is commonly referred to as "hyperinflation" or "runaway inflation."
Deflation, on the other hand, is defined by a steady drop in prices. When this occurs, consumers postpone their purchases in anticipation of lower prices in the future. As demand continues to fall, producers' prices continue to fall in order to attract buyers.
Moderate inflation is generally beneficial to the economy because it encourages spending and boosts economic growth.
Bitcoin and inflation
While the economics of the Bitcoin market are complex, some cryptocurrencies, including Bitcoin, are designed to be inflation resistant or to have predictable and low inflation rates. And, while Bitcoin is widely regarded as an inflation hedge, recent economic developments have resulted in Bitcoin performing less well as a pure hedge.
What role does Bitcoin play in inflation?
The cryptocurrency has become increasingly aligned with general market movements, owing largely to institutional investments. This means that if the market falls, Bitcoin will most likely fall as well.
As a result, when news of inflation arrives, the Federal Reserve will almost certainly enact a dual mandate. Policy interest rates will rise, and monetary policy will tighten. As a result, the value of assets (including cryptocurrency such as Bitcoin) will fall.
Do cryptocurrencies experience inflation?
Yes, cryptocurrencies, including Bitcoin, which is often regarded as "inflation-resistant," experience inflation. Bitcoin, like gold, experiences inflation as more of it is mined. However, because mining for new Bitcoin is automatically reduced by half every four years, inflation rates are bound to fall eventually.
Bitcoin's typical annual inflation rates aren't usually a major source of concern for investors as long as its value continues to rise against fiat currencies. Other cryptocurrencies, on the other hand, may perform differently.
Stablecoins, for example, are pegged to fiat money and are a low-volatility cryptocurrency that can be used to save money. Stablecoins, on the other hand, are subject to inflation and may lose value over time. Stablecoins lose value as their reserve currency loses value.
Is Bitcoin deflationary or inflationary?
Bitcoin is, in theory, an inflationary currency. This is because it was created to mimic gold's stable inflation rate. While the common definition of deflation may imply that Bitcoin is deflationary because its purchasing power rises over time, deflation actually refers to a decrease in the money supply (or substitutes thereof).
To be clear, deflation is more than just a drop in prices, though it is commonly defined as such. A monetary phenomenon that causes such a price decrease is referred to as deflation. As a result, Bitcoin cannot be deflationary because its supply will not decrease. Instead, it will gradually increase in supply until it reaches a hard cap of 21 million coins. (This is expected to happen around 2140.)
Bitcoin will be neither inflationary nor deflationary once this cap is reached. Instead, it will become deflationary, as planned, resulting in a constant monetary base and an unchanging supply.
Is Bitcoin inflation proof?
So, the question is, "Is Bitcoin a good inflation hedge?" While gold has long been considered the go-to inflation hedge, cryptocurrencies such as Bitcoin also offer excellent alternatives.
Rather than being "inflation-proof," which implies complete impenetrability against any external changes, Bitcoin is more of a "inflation-resistant" asset. Bitcoin, as the largest and most established cryptocurrency, is widely regarded as a good inflation hedge. It could even be regarded as a better hedge than gold.
Despite being more volatile than gold, Bitcoin offers better long-term growth prospects and thus protects against inflation. In what way?
Limited supply
Bitcoin's limited supply makes it an excellent inflation hedge. When the supply of an asset is fixed and limited, new coins cannot enter circulation, thereby eliminating the risk of inflation.
Not tied to a specific economy or currency
Bitcoin, like gold, is not owned by any one entity, economy, or currency. It's a global asset class that reflects global demand. Bitcoin is a better investment than stocks because it avoids the numerous economic and political risks associated with stock markets.
Easily transferable
Bitcoin, like gold, is long-lasting, easily interchangeable, scarce, and secure. Bitcoin has an advantage over gold because it is more portable, decentralized, and transferable. Unlike gold, which has a limited supply in sovereign nations, Bitcoin can be stored by anyone due to its decentralized nature.
Why is inflation important for crypto?
High inflation rates for fiat money may lead to increased investment in digital currencies to alleviate concerns about their fiat currency losing value over time. Cryptocurrencies such as Bitcoin (BTC) and Ether (ETH) offer an excellent alternative for investors looking to diversify their investment portfolios.
Benefits of Bitcoin’s fixed supply
Scarcity is one of the keys to making an asset resistant to inflation. Because Bitcoin has a limited supply, it remains scarce, ensuring that its value will remain stable over time, which is why it is referred to as "digital gold."
Satoshi Nakamoto, the creator of Bitcoin, intended for each unit of Bitcoin to appreciate over time. This was made possible by the limited maximum supply and the slow rate at which new Bitcoin is mined.
No new Bitcoin can be created once the maximum number of Bitcoin has been reached. Transactions will proceed as usual, and miners will continue to be rewarded, albeit only with processing fees.
What will happen to Bitcoin in a recession?
Bitcoin arose from the ashes of the 2007–08 financial crisis, dubbed the "Great Recession." Satoshi Nakamoto created Bitcoin in response to widespread bank failures in order to provide the public with a currency that did not rely on third parties or central authorities. As a result, a cryptocurrency independent of any entity or sovereign nation was created.
During a recession, negative economic effects can spread to countries with economic ties. Bitcoin can also serve as a recession-resistant asset due to its inherent diversification. While the US dollar is subject to the benefits and constraints of the US economy, such as GDP, export prices, monetary policy, and currency demand, Bitcoin is not bound by any single country's loss or gain.
Furthermore, Bitcoin has value regardless of how an economy performs. This is due to the fact that it is a scarce and secure asset. It is also internationally transferable. Bitcoin's primary purpose is to serve as a store of value, which is why it is expected to outperform other cryptocurrencies such as Ethereum during a recession.
How Bitcoin can help clients in the long run
Although Bitcoin is unlikely to dethrone major centralized currencies, it has altered the financial landscape since its inception in 2009. Its technology has enabled revolutionary advances in decentralized finance (DeFi) and benefits unbanked clients in remote and low-income areas.
Blockchain technology has enabled numerous advancements, but its primary function is to faithfully serve users. Blockchain technology, at its core, provides users with a secure, permissionless, and decentralized way to conduct financial transactions. Bitcoin, along with other crypto assets, serve as inflation- and recession-proof alternatives to fiat currency.