Can cryptocurrency work effectively as a hedge against inflation?
In April 2022, Nigeria’s inflation increased to 16.82%. According to the recent Consumer Price Index report released by the National Bureau of Statistics (NBS), this is the highest rate since August 2021. Globally, inflation rates are also on the rise. There are two significant reasons for the widespread increase in inflation - the Covid19 pandemic and, more recently, the invasion of Ukraine by Russia.
In the face of this economic downturn, how can crypto be used as a hedge against inflation? This article will serve as a brief guide to how that can work.
What is inflation?
Inflation is an increase in the price of goods and services in an economy, typically accompanied by a reduction in the value of the country’s currency. Inflation is why Kachi can only purchase one pack of spaghetti this year with the same amount of money he used to buy two packs last year. It is why Hauwa has to increase her hair braiding prices and why Chris has to pay twice as much to renew his domain name subscription this year.
Most economists regard inflation as healthy for the economy if it stays low and doesn’t reach disturbing levels or develop into hyperinflation. Low inflation rates encourage investing, spending, and borrowing, which are fundamental for strengthening healthy economic growth. When inflation gets out of hand, it leads to a rapid increase in the cost of services and goods while income stays the same.
The reduction in purchasing power caused by inflation is usually more devastating for people living in developing countries like Nigeria, India, and Mexico than in developed countries like Canada, France, and the United States. Citizens in the former will often have to make heavier financial adjustments and may even immigrate to the developed countries.
What Causes Inflation?
There are several reasons why inflation occurs, such as demand constraints, supply challenges, money supply policies and financial decisions made by the government. Here’s a quick rundown on the different reasons for inflation:
- Inflation caused by supply challenges is known as cost-push inflation. It happens when production costs increase while demand stays the same. As a result, the increased production cost is shifted onto consumers through higher-priced goods and services.
- Inflation caused by demand issues is called demand-pull inflation. It occurs when there’s a significant increase in demand for most goods and services within an economy. This leads to increased prices.
- A change in exchange rates can cause inflation, especially when one of the currencies involved is powerful (like the U.S dollar, for example). When the value of a currency like the Nigerian Naira falls in relation to the U.S Dollar, most consumer items in Nigeria go up in price.
How does the government affect inflation?
Inflation caused by government fiscal policies or decisions can occur in several ways, such as:
- If the government reduces taxes for individuals and businesses, there would be an increase in spending power, which leads to increased demand and, in turn, increased prices.
- If the government prints more money than what the economic growth rate needs, demand and prices will rise.
- If the government imposes new tariffs or laws that make production or service delivery more expensive for companies, these companies can push the expense onto customers. And, of course, prices will rise.
- If the national debt of a country shoots through the roof and the government has to either raise taxes or print more money to pay off the debt, either option taken can lead to inflation.
Essentially, government actions and policies have the potential to cause both cost-push and demand-pull inflation at the same time.
What are hedges available for use against inflation?
It won’t be an exaggeration to say inflation is unavoidable. Hence for years, people have been searching for ways to prevent their money from losing value to inflation. Real estate, stocks and gold are the most common hedges available. For a hedge to be a solid pushback against inflation, it should have the capacity to maintain stable value or increase in value as time passes.
Real estate is arguably the best hedge against inflation. For instance, If you purchase a piece of land, the value will likely increase over time. However, real estate prices are significantly affected by factors such as political stability, infrastructure, geographical location, economic stability and government policies. This can pose a challenge to the average joe, who cannot comprehend the nuance of investing in real estate. In addition, it is pretty expensive to invest in real estate.
In the case of gold as a hedge, it is no longer a reliable choice as it was before the pandemic. It still has some use for holding value, but the general interest in gold seems to be reducing daily.
For stocks, the key to finding great stocks to buy is finding strongly valued companies that are well backed and offer good dividends for shareholders. Also, not all stocks can survive inflation and its economic impacts.
Can cryptocurrency work as a hedge against inflation?
Traditional asset value holders such as real estate and stocks are controlled by centralized authorities, which makes them susceptible to biases, greed-fuelled pressures and discrimination. Unlike the decentralized crypto ecosystem that pushes for and encourages accessibility for everyone, the traditional financial system tends to be less inclusive. With that being said, can a case be made for cryptocurrency to be considered a reliable inflation hedge?
Most people might presume that due to the fluctuating nature of crypto, it may not have the capacity to be an efficient hedge. Cryptocurrency is split into typical coins/tokens like Bitcoin, Solana, Cardano, Ether and stablecoins such as Tether USDT, Binance USD, and USDC. Both categories function differently as hedges.
Let’s look at Bitcoin as a case study for using typical cryptocurrency as an inflation hedge. In 2021 — which was a slow year for Bitcoin — the cryptocurrency grew at 59.8%, significantly higher than the inflation rate in most countries. Remember, one of the goals of a hedge is to stay above the inflation rate to preserve value.
On the other hand, we have stablecoins. Stablecoins are cryptocurrencies created to counteract the price fluctuations in crypto trading by linking their value to an asset like the dollar that is prone to less unpredictable changes in price. Fiat-backed stablecoins like BUSD, USDC and USDT can function effectively as a hedge against inflation, seeing as they have a value equivalent to 1 U.S dollar; this means I 1 BUSD = $1, 1 USDC = 1$ and 1USDT= $1.
In an economy grappling with high or hyperinflationary rates, cryptocurrency can serve as an easily accessible hedge. It’s as simple as buying some USDT for instance, from a crypto exchange and holding it in your wallet. To illustrate further, Let’s say you purchased 100 USDT at ₦39,000 ( ₦390 = 1 USDT) in 2020 and saved it in your crypto wallet. Today, at the current exchange rate of ₦601 = 1 USDT, your 100 USDT is now worth ₦60,100.
What are the benefits of using cryptocurrency as a hedge against inflation?
Saving your money in crypto when compared to buying stocks or gold, or real estate as a means of hedging off inflation offers multiple benefits such as:
- Ease of accessibility: It is much easier to create a crypto account and purchase coins than to buy a house, land, gold, or even stocks.
- Less expensive: All you spend while buying crypto is the amount equivalent to the USDT, BTC or ETH you wish to purchase. There are no hidden charges or extra charges.
- It is decentralized: Unlike traditional asset classes that are majorly controlled by government authorities, cryptocurrency has more freedom. There are no worries about the authorities deciding to bulldoze your property or seize your land without warning.
Inflation can be positive for the economy, but it becomes problematic when it becomes hyper or out of control. In inflationary situations or even before hyperinflation hits, people are constantly looking for where to invest their money to preserve its value. Real estate, stocks and gold have been the go-to for ages.
Over the past years, cryptocurrencies have shown potential for use as a hedge against inflation, particularly for people living in developing countries. It is less expensive and more accessible than real estate and gold, making it the perfect choice for the average person who wants to secure their money against the harsh winds of inflation.
You can kick off your inflation hedge process by creating an Obiex account today in less than 90 seconds. Tap here to begin.