How Inflation Affects Cryptocurrencies

Learn more about the basics of inflation, and how cryptocurrency can be used to combat its effects.

The Philippines' inflation rate hit 4.9% in April, the highest since January 2019. In Southeast Asia, inflation has risen to 3.7%. With inflation on the rise around the globe, how will that affect digital assets? In this article, you’ll learn the basics of inflation, the role crypto plays during inflation and how you can use USD-backed stablecoins as a stable hedge against inflation.

What is inflation, anyway?

Inflation occurs when a country's currency value drops and the cost of everyday items increases. In an economy, inflation reduces the purchasing power of the currency. As a result, it becomes less valuable over time. In Venezuela, for example, the inflation rate reached over 1 million percent in 2018. This created financial instability for its citizens because they could no longer trust the value of their money.

Similarly, if the value of the US dollar drops from $1 to $0.50 and the price of goods also drops from $1 to $0.50, then the country is experiencing inflation of 50%. Inflation can make it very difficult for people to buy things they need or want.

Cryptocurrencies – an inflation hedge?

Stablecoins offer a solution to the lack of financial stability in countries that have high inflation rates by giving people a more stable currency. For example, USDC was created to give people a stable currency that can be used in exchanges and pay for goods and services online and in the real world. Stablecoins like these could help make cryptocurrencies more accessible to consumers around the world. In other words, people can hold their wealth in USDC to hedge against inflation.

The same cannot be said for cryptocurrencies like Bitcoin or Ethereum. The big advantage of cryptocurrencies is that you can usually transfer them instantly around the world for little or no cost, which makes them ideal for cross-border transactions and payments. However, this makes them subject to the same inflation and price fluctuations as all currencies, so they won't always be a good hedge against inflation.

How Does Inflation Affect Cryptocurrencies?

Inflation affects the value cryptocurrency has in money units over time. If the value of a cryptocurrency rises rapidly, for example if the economy is doing very well, then people might be more willing to buy the currency in exchange for goods and services. This increased demand drives up the price and the value of the currency rises even higher. But if inflation is high and the economy is not doing so well, then people might be less willing to buy cryptocurrency, since the value of the currency is falling and losing value over time.

“There was a time when you could think about Bitcoin as a way to diversify from the market but that’s no longer the case," said Merav Ozair, a blockchain expert and fintech professor at Rutgers Business School. “When people panic, they panic cross-border.”

While it’s reasonable to think that digital assets will be insulated from inflation, that’s not how it has always played out in practice.

Another Idea

In the US, inflation rose to 7.9% in February. Globally, inflation has risen to 3.7%. In contrast, most banks offer you 0.1 - 0.25% on their savings interest accounts, which means that any money you hold in a traditional bank account is steadily losing value every year due to inflation.

For investors hesitant about crypto's volatility, another idea is to consider using stablecoins to obtain a staking yield as an inflation hedge. With crypto savings accounts, you can earn anywhere from 5-15% on the value of your assets every year. For example, Finblox has up to 15% yield on stablecoins and up to 90% on more volatile assets like AXS and ETH. This is much higher than traditional currency strategies.

Bottom Line

Inflation is catastrophic when it spins out of control. As spending increases and economies open up after the COVID-19 pandemic, inflation is expected to continue to rise in the near future. As a result, individuals and companies invest in real-world assets like gold, commodities and real estate to protect themselves from future inflation. However, cryptocurrencies have also demonstrated that, like those assets, they too play a role during inflationary periods.

DISCLOSURE:

This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. Charts, graphs and references to any digital assets are for informational and illustrative purposes only.

Finblox Blog is associated with Finblox - a reliable cryptocurrency earnings platform where you can buy and earn passive income on your digital assets.

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