One feature that has attracted investors to cryptocurrencies, notably Bitcoin, is the notion that they are more resistant to inflation than fiat currencies such as the USD.
But what exactly is inflation? Inflation is the process through which currencies lose value over time, causing consumer goods prices to rise.
Because most economists think that some degree of inflation is beneficial to the economy, the US government, for example, has issued more money than consumers need for decades. That’s why a five-cent coke from half a century ago today costs a few bucks.
Bitcoin, on the other hand, surged in value significantly quicker than the USD, rising from nearly worthless in 2010 to more than $20,000 by the end of 2020. (Because the market is unpredictable, Bitcoin has witnessed dramatic gains and falls, but the trend has been higher over time.) As a result, Bitcoin has become an increasingly attractive alternative to fiat currency inflation.
The key method Bitcoin is intended to fight inflation is that its supply is restricted and known, with the generation of new bitcoin diminishing in a predictable pace over time. (There will only ever be 21 million bitcoin, and the number mined is half every four years.)
Why is inflation important for cryptocurrencies?
A high rate of inflation for fiat currencies may induce consumers to invest more in digital money since the dollars or Euros they deposit in a savings account lose value over time. Bitcoin and other cryptocurrencies, such as Ethereum, provide investors with an alternative. The Bitcoin market economy is complicated, but the digital currency has some characteristics that may aid in its resistance to inflation.
- Governments cannot influence Bitcoin by changing interest rates or creating additional money to accomplish political aims.
- The traditional thinking about Bitcoin, like gold and other precious goods, is that its price rises during times of uncertainty. (However, this was not always the case; for example, during the commencement of the COVID-19 pandemic, it sank rapidly along with the stock market.) It’s also a lot more convenient manner of storing and transmitting value than gold, and it can be transmitted through the internet.
- Scarcity is an important aspect in making value storage resistant to inflation. There will never be more than 21 million bitcoin in existence. Approximately 19 million bitcoins have been mined as of now. Miners process a new “block” every ten minutes, and 6.25 bitcoin is added to the network. (By 2024, the mining reward will be reduced to 3,125 bitcoin, then halved every four years until all bitcoin has been mined.) Splitting is a technique included into the Bitcoin system.)
- Because new Bitcoin cannot be “found,” this planned drop in fresh supply over time makes Bitcoin particularly predictable.
Do cryptocurrencies register inflation?
Yes, Bitcoin theoretically tracks inflation as it is mined (like gold). However, since the supply of new bitcoin is automatically lowered by half every four years, Bitcoin’s inflation rate falls.
In practise, as long as the purchase power of Bitcoin continues to rise relative to the fiat currency to which it is often compared, an annual inflation rate of a few percent is not a significant aspect for investors to consider.
However, not all cryptocurrencies are constructed in the same way as Bitcoin. Stablecoins, a growing category of digital money that is often tied to fiat currencies such as the dollar, may be a beneficial low-volatility alternative to conserving money. However, if a stablecoin is connected to a fiat currency, your investment will be influenced by inflation and may lose value over time as the associated reserve currency depreciates. (Some stablecoins give benefits that are extremely comparable to an interest-earning savings account, which might modify the equation, particularly when non-cryptocurrencies’ interest rates are near zero.)
