With an ongoing war in Europe and the world entering its third year under COVID-19, the American economy continues to take blows. One particularly notable consequence of recent events has been rising inflation. CNBC reports that our consumer price index (or CPI) has increased by 7.9% over the past year –– the fastest acceleration the economy has experienced since 1982.
If you’re an investor, you may be rightly worried about how this is affecting the value of your portfolio. You might also be considering further investment in assets that can act as hedges against inflation, like gold, real estate, or collectible items. However, there’s also another option you can try: cryptocurrency.
Though crypto is a relatively new asset in the world of investments, it’s already beginning to prove its potential in protecting users from inflation. Here’s how:
What is inflation, anyway?
Before getting into how exactly how crypto protects against inflation, it’s best to recap what inflation really is (beyond scary news headlines). A guide to inflation by AskMoney explains that the term refers to the tendency of money’s purchasing power to decrease over time. For example, $0.34 was enough to buy a gallon of milk in 1920; today, you’d need $3.50 to buy that same gallon. The rate of inflation is determined by a number of things, however, ranging from national debt and government regulations to economic growth and exchange rates.
When it comes to your investments, inflation can decrease the value of a portfolio over time –– which is why crypto is so appealing to some as a hedge against it.
How can crypto protect against inflation?
It’s decentralized
One reason crypto is viewed as a hedge or protection is that it was designed to be decentralized. PWC’s crypto overview explains that structurally, this means that the blockchain technology crypto is built upon distributes it over a worldwide network of computers. This setup allows users to acquire and trade crypto with each other without the need for financial institutions like banks to act as middlemen. In turn, this means that crypto isn’t tied to any one economy and is instead a kind of borderless currency with a value that reflects global demand. Unlike stocks or bonds, its worth is thus unaffected by political and economic risks like inflation.
It’s finite
Many digital currencies are designed to have limited supplies. The standout example is bitcoin, which has a fixed supply of 21 million coins. As of late 2021, Yahoo reports that 90% of those are already in circulation (nearly 19 million tokens). This means that no new coins can enter circulation even after the remaining 2 million are unlocked through crypto mining. This ultimately eliminates risk of inflation.
By comparison, fiat currencies like the U.S. dollar are prone to inflation because the government can easily increase the country’s money supply to lower interest rates. Doing so, however, reduces the dollar’s purchasing power.
It’s liquid
Like gold, real estate, and collectible items, cryptocurrencies represent a good store of value in that they’re secure and scarce in supply. However, crypto arguably offers some additional advantages in protecting against inflation. Above, we established that crypto is decentralized. This means its value is also easily transferable. We’ve previously demonstrated how bitcoin can easily be converted to fiat currencies like the Canadian dollar. As a result, it can be said that crypto is more liquid than other hedges against inflation. Periods of inflation devalue money and make it less liquid, whereas crypto remains liquid due to its decentralized nature.
If you’re worried about the current economic climate, it’s always good to invest in assets that are relatively unaffected by inflation. That’s not to say there’s ever such a thing as a wholly “safe” investment. But by adding crypto to the mix, you not only diversify your portfolio but increase the likelihood that its value stays intact even through economic difficulties.
