There are plenty of arguments about whether cryptocurrency is inflation-proof, inflation-resistant, or neither. Whilst some believe that investing in crypto is the best option during inflation, others believe the opposite. Since inflation is a complex concept and cryptocurrency is volatile, it’s difficult to conclude how inflation affects crypto.
However, we still aim to break down the concept of inflation and analyse its potential impact on the crypto industry. This will help you to understand the relationship between inflation and crypto so you can decide how to respond during inflationary periods in regard to your investments. In this article, you’ll learn what inflation is, how it’s caused, and how it affects crypto.
What Is Inflation?
Inflation refers to the increase of prices over a set time period, such as a year. Whilst in any economy, prices will rise and fall, inflation occurs when there is a large increase in prices across the board. This means that most services and goods have become more expensive over a certain time period. Since, during inflation, prices increase, the value of the currency will decrease, which also decreases its purchasing power. So, during inflation, the same amount of money you spend will now get fewer goods and services compared to, say, a year ago.
The opposite of inflation is deflation, and this is when prices decrease over a set time period. Additionally, hyperinflation occurs when there are extremely high levels of inflation that severely impact an economy.
How Is Inflation Measured?
Although it varies between countries, inflation is typically measured by comparing the current prices of goods and services to their previous prices. Although this seems fairly simple to do, it’s actually quite a complicated process. For instance, the CPI (Consumer Price Index) is a method that is used by many countries to measure inflation.
CPI can track inflation by measuring the overall change in prices based on a representative sample of goods and services. So, governments will record a set number of prices from retail and service establishments across the country. They will then create a total value of this basket.
Governments gather a selection of goods and services most commonly purchased by citizens to form a true representative value. This can include everyday items, medical care, shelter, luxury goods, transport, and utilities. The CPI of a country is usually publicly available and can be accessed by citizens. For example, you can see the United State’s current CPI on the official U.S. BLS website.
Once this value has been established, it’s divided by the value of the basket of a different time period. So, the CPI formula is as follows:
Cost of goods or services in the current period / cost of goods or services in a previous time period x 100 = CPI
We must admit that accurately calculating the CPI to measure inflation is a bit more complex than this. However, this explanation is all you need to get an idea of how inflation is measured in most countries.
What Causes Inflation?
There are several factors that can cause inflation. For example, cost-push inflation occurs when the price of production increases. This results in the final product being more expensive than before. Alternatively, demand-pull inflation occurs when there is more demand than aggregate supply, resulting in goods or services rising in price.
Furthermore, some companies may have the expectation that prices will increase, causing inflation. This may lead them to increase the prices of their goods and services in preparation. Workers may also anticipate inflation for one reason or another and, as a result, will demand higher wages.This can become a self-fulfilling prophecy as the actions resulting from an expectation of inflation can add to a higher rate of inflation.
How Does Inflation Affect Crypto?
We should now be fully aware of what inflation is, how it’s measured, and what can cause it. Now it’s time to discover how inflation can affect crypto!
When comparing crypto to the CPI, it appears that as consumer prices increase, the price of many cryptocurrencies decreases. This can be due to citizens having less disposable income that they can spare to spend on crypto. So, if the prices of all your goods and services go up, you’ll want to focus on making sure you still have enough money to spend on necessities such as food and bills. This means you’ll likely be less inclined to spend money on buying crypto.
Crypto Inflation
Similarly, citizens who are financially struggling as a result of inflation may choose to sell their crypto holdings. If this is done on a large scale, it can result in a decrease in the value of many popular cryptocurrencies. This will then lead to crypto inflation. Additionally, during times of economic instability, citizens typically seek stability elsewhere. This often results in an increase in investment in precious metals and other assets that traders view as stable, as opposed to crypto.
On the other hand, citizens who have noticed that the fiat money (Euros, Pounds, Dollars) in their savings accounts are losing value over time due to inflation may choose to invest these funds in crypto assets instead. Before crypto became a popular asset to invest in, this was usually the role of gold, which was often used as a hedge against inflation.
Additionally, in countries where the fiat currency is unstable, and hyperinflation is a risk, citizens use cryptocurrency as a store of value. However, this is only the case for cryptocurrencies, such as Bitcoin, that are known to be stable.
How Inflation Impacts Different Cryptocurrencies
Although citizens may choose to turn to crypto investments during inflationary periods, this does not mean that all cryptocurrencies will be positively impacted. As we’ve mentioned, those that choose to invest their money in crypto will likely focus their attention on well-known and stable cryptocurrencies, with the obvious example being Bitcoin.
Bitcoin (BTC)
Bitcoin is not only the world’s most popular crypto but it is also the most valuable and has the highest market cap. As a deflationary asset, Bitcoin is often the go-to option for traders who decide to invest in crypto during inflation. Since this coin’s creation in 2008, it has had a total supply of 21 million coins. This means that this is the max amount of Bitcoins that will ever exist.
Along with its capped supply, Bitcoin is becoming harder to mine. As time goes on, this coin’s supply will decrease, which, in turn, will increase its value. Because of this, Bitcoin has become a great option for investors during inflationary periods.
Stablecoins
Stablecoins are another type of cryptocurrency that can benefit traders during inflation. The value of stablecoins is pegged to the value of another asset, such as a fiat currency. For instance, stablecoins Tether (USDT) and Binance USD (BUSD) have a 1:1 value of the US dollar. Since the value of stablecoins is tied to other currencies, they are much more stable than most types of crypto. This makes them a good option for many traders.
Stablecoins can also be helpful for investors who are located in countries that suffer from inflation and instability. Well-developed countries that have stable economies are more likely to have fiat currencies that are more resistant to inflation. On the other hand, less stable countries will often have fiat currencies that higher rates of inflation impact, making it much harder for citizens to save money. For these citizens, investing in stablecoins that are pegged to inflation-resistant fiat currencies can help them to hedge against inflation.
Unfortunately, this isn’t the case for all cryptocurrencies. Many cryptos, especially new projects or coins that do not have any other real-world uses aside from being used to make transactions, are much less stable than deflationary cryptocurrencies such as Bitcoin or other digital assets such as stablecoins. This means they are likely not great options for investors who want to withstand pressures from inflation. However, since crypto as a whole is quite new, we cannot say for sure whether inflation positively or negatively impacts the industry.
Should I Still Purchase Crypto Despite Inflation?
You may be wondering whether it’s still worth purchasing cryptocurrency during periods of inflation. Unfortunately, the answer varies between each trader, and several factors influence it. For example, the country you live in can affect whether or not investing in crypto can be beneficial. This is because, as we’ve mentioned, stablecoins can be purchased to help citizens who live in countries with unstable economies.
Furthermore, your personal financial situation will determine whether you should still purchase cryptocurrency during inflation and price rises. If almost all of your income is put towards buying necessities, then it may not be a good idea to put the remaining income into cryptocurrency.
On the flip side, if you do have a significant amount of money left over after buying necessities, investing in crypto can help you to steadily build up wealth even during inflationary periods. This is why it is vital to consider your financial situation, goals, and location before deciding to invest in crypto.
Additionally, your experience as a trader can also impact your decision to invest in cryptocurrency during inflation. If you already have plenty of experience as a trader, then, in most cases, you have a better chance of making good investment decisions that can help you hedge against inflation.
Extra Assistance
Don’t worry, however, if you’re an inexperienced trader! You can still choose to invest in cryptocurrency and navigate the crypto market, even during inflation. As long as you do plenty of research, set yourself goals, and never invest more than you’re willing to lose, you too, can profit from your investments. If you’re hesitant to make investment decisions alone, or you think you’ll benefit from additional support, then you have the option to use the services of a financial advisor or crypto broker.
A crypto broker can be the most helpful service for inexperienced traders since they provide tools designed for beginners. Choosing the right broker for your needs can be tricky. This is because there are so many options available, and not all of them have your best interests at heart. That’s right, not all crypto brokers can be trusted, and some only exist to deceive and capitalise on unsuspecting traders.
To make sure you’re connecting with a suitable broker, we suggest using a crypto platform. These crypto platforms partner with well-rounded brokers who are equipped with useful tools that you can use to your advantage as you trade on the crypto market. Also, by using a crypto platform, you don’t have to waste any time searching for a suitable broker on your own. This is because these platforms typically use AI technology to pair you with a broker who you’re most compatible with.
Using a broker can help you build confidence since they can offer support as you use the crypto market and create your trading portfolio with various crypto assets. That’s why we recommend using a crypto broker, regardless of whether you invest during an inflationary period or not!
Conclusion
To conclude, inflation can impact all kinds of industries, and the cryptocurrency market is no exception. As consumer prices rise, some investors may choose to invest in crypto to combat inflation. Others may stray away from the market altogether. Each trader is different, and their own situation can impact whether crypto investing is a good decision or not.
Cryptocurrency plays an important role during periods of inflation. But since this asset is still in its infancy, we don’t know for sure how it is impacted. If you’re considering investing in crypto during inflationary periods, then we highly recommend doing plenty of research before making any financial decisions. Safe trading!
