An inflation hedge is an asset or investment that maintains or increases its value over time while protecting against decreased purchasing power and its adverse effects. Inflation in fiat-based economies is imminent, hence, the need for buffers against the adverse effects of inflation. Store of value investments such as Gold, stocks, real estate, bonds, or precious metals has been considered tools and investments that have worked as hedges for a long time. Cryptocurrencies have currently been embraced by the U.S. Securities and Exchange Commission as investable assets. Store of value assets and good inflation hedges, known as hard assets, should be capable of holding purchasing power over time. Fundamental properties linked with hard assets are scarcity, accessibility, and durability.
Crypto As a Store-Of-Value
Utility and scarcity are critical prerequisites to value, both of which are inherent in cryptocurrencies. The utility is the purpose of these cryptocurrencies and the problem they seek to address or improve processes. Scarcity refers to the number of digital coins or tokens in circulation. Regarding utility, one can use bitcoin as a store of value, ether to implement a pre-programmed code through smart contracts, and litecoin for payment of goods and services. Use cases and increased adoption are growing, indicating an interest in replacing current systems. Fiat currencies decrease in value over time due to money creation by central banks, but cryptos resist this devaluation because of their fixed supply. For instance, Bitcoin has a fixed supply of 21 million units. Cryptos derive their value from their use as mediums of exchange and stores of value. For an asset to be a store of value, it must have intrinsic value derived from a practical utility. The cryptos’ utility as stores of value is dependent on their utility as a medium of exchange. Cryptos will, therefore, have to be effective facilitators of transactions. Ubiquity will be necessary to increase their value; this is termed the network effect. The more acceptable the currency, the more flexible it facilitates transactions, stabilizing its value. For cryptos to efficiently behave as a store of value, the market needs to be dominated by long-term investors who can withstand volatility and price drops and lend support and stability to the asset. According to Goldman Sachs publishing research, common frameworks, metrics, and classifications used across market participants should be developed, deeming cryptos a “store of value” to compete with gold. Cryptocurrencies will then trade as inflation hedges other than risk assets.
Cryptocurrencies As an Inflation Hedge
Cryptos are gaining wider adoption, gradually trading more like stores of value owing to their limited supply. Bitcoin, for example, is deemed even scarcer than gold as its upper supply limit is fixed, whereas gold continues to be mined physically, thereby gradually increasing supply every year. According to the CEO and founder of Parallax Digital Robert Breedlove, BTC’s endgame is to one day become a risk-free asset and a safer store of value. Fidelity Digital Asset Manager stated that cryptos are unique in that some perform as a payment technology and as forms of money. Looking into the query «Can Cryptocurrencies prevent inflation?» Limited supply and decentralization are the two primary considerations as they bring scarcity and resilience power to cryptocurrencies, making them effective hedges against inflation.
Each coin’s nuanced approach as to what constitutes scarcity should be considered. The scarcity of a particular cryptocurrency such as bitcoin, ether, or litecoin may affect price action, especially when considering bitcoin’s halving event and the Ethereum protocol’s ‘ice age.’ All Cryptocurrencies are unique in their ways. However, there are outlined limitations to the supply of digital currency units in almost all cases. Bitcoin and Ether control supply differently. Ethereum’s reward structure has five units of ether created every 15 to 17 seconds. There is about 99 million ether in circulation with no finite supply since the use of the network itself causes ethers to be destroyed naturally. Bitcoin’s supply (BTC) is algorithmically capped to 21 million coins. Like gold, it is scarce and has a low correlation to other assets. This supply cap raises the demand for the asset increasing its prices. Bitcoin’s pre-set limit means no excess supply, keeping inflation in check. The coin’s annual rate of mining dips by every four years. Bitcoin’s annual production is expected to be approximately half of gold’s and will continue dipping, making it scarcer than gold.
Decentralization eliminates control by a centralized authority. The Bitcoin network is resistant to external attacks seeking to change its monetary policy. These attacks might jeopardize the sought-after scarcity of the digital coin. In terms of decentralization, no other currency compares to Bitcoin. Anyone can run a Bitcoin node to verify transaction history and relay transactions. Cryptocurrencies cannot be double-spent in cases of extensive decentralization. It’s because of high decentralization that Bitcoin prevents centralized control of info, while also distributing the process of decision making. Basically, all Bitcoin holders can participate in decision-making.
Limited supply and decentralization propel cryptocurrencies to unique positions as assets that can keep inflation at bay. However, if you’re planning to invest in crypto, make sure to form a good understanding of the market for maximum returns.