How to preserve capital during inflation using cryptocurrencies?

Just as the global economy largely recovered from the devastating effects of the COVID-19 pandemic, geopolitical tensions and resulting supply chain pressures once again disrupted financial markets around the world.

In addition, inflation reared its ugly head again, forcing central banks in major economies to raise interest rates in a bid to curb runaway prices for essential commodities like food and fuel.

Despite these efforts, developed economies such as the United States and the United Kingdom continue to report inflation at multi-year highs, adding further pressure on household savings and negatively impacting consumer spending.

In addition to the threat of an impending recession, these inflationary pressures have a negative impact on the value of fiat money in the hands of consumers and highlight the need for financial tools or assets that can act as a hedge against inflation.

Impact of current inflation on the world economy

Along with its impact on the purchasing power of a country’s fiat currency, inflation has a detrimental effect on the true returns generated by financial instruments, especially if the rate of inflation exceeds the rate of return on investment.

Take, for example, the S&P 500 Index, which comprises the top 500 publicly traded companies in the US and acts as a benchmark index for the country’s stock markets. Having generated an average annualized return of 11.82% since its inception in 1928, the performance of this index can appear quite spectacular from the outset.

However, with the Consumer Price Index (CPI) rising to a 40-year high of 9.1% in June 2022, the returns generated by investments made in mutual funds that track this index will be significantly lower.

In fact, the index has provided an inflation-adjusted historical average annual return of just 8.5%, that too when the average CPI has been much lower than currently reported numbers.

Also, when the Federal Open Market Committee (FOMC) voted to raise the US Federal Reserve interest rate to a four-year high of 2.25% in July 2022 , the US dollar has appreciated significantly against a basket of fiat currencies, including the euro, the Great British pound and the Japanese yen.

While this has helped soften the prices of commodities like crude oil, it has a negative impact on the value of investments made by US citizens and businesses in general in these economies.

For savvy investors allocating capital to emerging markets like Brazil, India, and China, among others, the devaluation of these countries’ fiat currencies against the USD has only served to diminish returns on investments made in these markets.

What does inflation mean for cryptocurrencies?

Compared to fiat currencies, cryptocurrencies like Bitcoin (BTC) have generated stellar returns for early-stage crypto investors. While the USD index has appreciated around 8% since August 2019, BTC is back ~240% in the same period based on current prices.

This is despite BTC correcting by ~60% from its November 2021 peak, further hinting at its long-term wealth creation potential. It can even be said that Bitcoin can protect people from the negative effects of inflation.

Related: Bitcoin and Inflation: Everything You Need to Know

A similar trend can be seen among other popular cryptocurrencies such as Ether (ETH), BNB Coin (BNB) and Ripple (XRP), suggesting that cryptocurrencies are a good investment during periods of high inflation with the potential to generate savings for the retirement that exceeds inflation.

Obviously, it is important to note that cryptocurrencies show much higher volatility compared to fiat currencies and are considered assets rather than pure currencies. Another aspect that favors cryptocurrencies like BTC is their limited supply of tokens.

With the original developer team setting the maximum Bitcoin supply at 21 million BTC, it is not subject to the seemingly discretionary way fiat currencies like USD are printed.

This implies that under no circumstances will the amount of BTC in supply exceed the set limit, which bodes well for its long-term price appreciation potential. Even for cryptocurrencies like ETH that do not have a prescribed maximum supply limit, the minting mechanism for new tokens is based on code and computational work done.

No entity can issue ETH tokens without having created a new block on the Ethereum blockchain, and the block reward mechanism depends on set factors, such as the complexity of calculations performed by miners.

Compare this to the arbitrary way the US Federal Reserve or any other central bank in the world prints money and it is clear that cryptocurrencies operate in a much more transparent and democratic way.

Are stablecoins a hedge against inflation?

Among the broader cryptocurrency market, an increasing number of crypto tokens are being released that are being created specifically to offer a better alternative to fiat currencies.

Known as stablecoins, these cryptocurrencies are pegged to other traditional assets like the US dollar and gold, and their prices are kept stable by holding reserves equal in value to the number of tokens in supply.

While some stablecoins are also algorithmically backed or pegged to another cryptocurrency native to the same blockchain protocol, they all aim to provide cryptocurrency investors with a means of exchange that can be freely transacted across geographic borders. .

Compared to fiat currencies or commodities like gold, stablecoins are potentially more suitable because:

Benefits of stablecoins compared to fiat currencies or commodities

This is especially important for people native to countries like Turkey, Argentina, Ethiopia, Zimbabwe, or Lebanon, where hyperinflation has rendered their fiat currencies a risky medium of exchange. Typically used to describe a monthly inflation rate of more than 50%, hyperinflation refers to a situation in which there is a rapid and uncontrollable increase in the prices of important goods and services in an economy.

As hyperinflation continues to erode the value of their currencies, people in those countries could switch to stablecoins like Tether (USDT), USD Coin (USDC), or Binance USD (BUSD) to protect their capital from rapidly eroding inflation. wealth.

By holding their savings in the form of stablecoins, they could preserve capital during inflation using cryptocurrencies and also benefit from the appreciation of the underlying parity to even increase the value of their savings.

Since this is sacrosanct even in a regime of high inflation and interest rates, hyperinflation has minimal effect on cryptocurrencies like stablecoins. Therefore, for investors in economies plagued by high inflation, cryptocurrencies can also act as an optimal investment.

Is it a good idea to put your money in crypto during inflation?

While there have been cases of cryptocurrencies failing miserably due to security issues, fraud, or a combination of the two, there are plenty of cryptocurrencies that have stood the test of time and continue to attract hordes of investors.

Related: How Can Third World Countries Counter Inflation Using Bitcoin?

In addition to BTC and ETH, altcoins like Avalanche (AVAX) and Polygon (MATIC), among others, could be a long-term hedge against inflation. Investors could allocate some capital to these cryptocurrencies for potential long-term gains while also using products like staking pools to earn additional income from these investments.

Based on historical data, it can also be a profitable strategy to invest wisely in cryptocurrencies that are currently trading near important support levels and simply hold them as a hedge against inflation.

On the other hand, stablecoins, along with other cryptocurrencies, can be held in a digital or hardware wallet just like fiat currency in a traditional bank while helping investors protect their wealth from erosion. in a hyperinflationary environment.

In other words, stablecoins are safe from inflation compared to currencies like the Turkish lira, especially when pegged to the US dollar. That said, there are some stablecoins that have been notorious for trading below par, and investors would do well to maintain a cautious approach when trading or investing in them.

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