Cryptocurrency has been described as many things, from an excellent store of value to a hedge against inflation. As we continue to see rising prices in today’s economy, you may have questions about Bitcoin inflation and what it means for your investments.
In this article, we explore the ties between inflation and Bitcoin and whether Bitcoin is the hedge against inflation it has been touted as.
Understanding Bitcoin Inflation
What Is Inflation?
To better understand the relationship between Bitcoin and inflation, let’s first define inflation and its relevance today.
Inflation is viewed as an upward trend in the price of goods over time, occurring when a currency’s purchasing power declines. In other words, it is the rate at which a currency’s value falls and the prices for products and services, in turn, rise.
For example, let’s say a particular bottle of wine was priced at $10 in 2021. If that same bottle of wine is $20 in 2022, then it experienced an inflation rate of 100%.
The price of the product increased as the purchasing power of the U.S. dollar used to purchase the wine decreased. When this upward trend continues amidst an unstable economy, it can theoretically help increase production.
Depending on who you ask, inflation can be a positive or negative thing. Moderate inflation helps increase spending and economic growth, leading to a healthier overall economy.
But when this increase happens too quickly, consumers tend to purchase goods in bulk, which increases demand and pricing. This leads to a sense of panic and a phenomenon known as hyperinflation.
On the opposing side, when a currency’s purchasing power increases over time (usually due to a shortage of money in circulation) the currency is considered deflationary. Deflation is commonly associated with declining prices of products.
So, between inflationary and deflationary currencies, which category does Bitcoin fall under? Let’s take a look.
Is Bitcoin Inflationary Or Deflationary?
The simplest answer is (again): It depends on who you ask.
By definition, Bitcoin is technically deflationary. Since the supply of Bitcoin is limited to 21 million, the inflation rate of this currency is generally very low, and its purchasing power increases over time.
Deflationary currencies can usually be identified by the following:
- They cannot be produced at a moment’s notice.
- The supply is inherently limited.
- Their value traditionally increases due to a fixed supply.
With these definitions, it’s easy to categorize USD as inflationary and BTC as deflationary. The creators of the digital currency even designed it so that its inflation rate mimicked the stable inflation rate of gold.
A more traditional definition, however, may suggest this is not the case. Yes, the purchasing power of Bitcoin is still increasing, but another definition of inflation is an increase in the supply of money not backed by gold.
Since Bitcoin’s supply does currently increase over time, some argue that this puts it in the inflationary category. Still, the general consensus is that Bitcoin is deflationary by nature.
Can Bitcoin Hedge Against Inflation?
Due to its increase in purchasing power, Bitcoin has been deemed a hedge against inflation. This means that some people see Bitcoin as an effective addition to your portfolio to protect your investments from the impacts of rising prices.
On one side, Bitcoin’s value has skyrocketed in recent years, especially compared to the rate of inflation. Possessing an asset that sees a greater rise in value than the rate of inflation can help ensure that your purchasing power is not considerably impacted.
Taking this unprecedented increase into account, an argument could be made that Bitcoin is a reasonable hedge against inflation. Studying Bitcoin’s performance during recent inflation, however, we see a different story.
As of today, the U.S. is experiencing its highest year-over-year inflation rate in four decades. Since Bitcoin is meant to be the answer to rising inflation, how has it performed during today’s historic inflation?
The truth is: not ideally. Although we all hope that Bitcoin is the perfect investment whether fiat currency plummets or not, this belief is speculative. While it may be the solution to losses in purchasing power in the future, Bitcoin is not performing the way you might expect an inflation hedge to when it’s needed most.
Which angle you view it from determines how viable of an answer Bitcoin is against inflation, but how do other cryptocurrencies fare during economic uncertainty?
How Do Other Cryptocurrencies Fare Against Inflation?
Stablecoins are the answer if you’re looking to avoid volatility. Unlike most altcoins, these currencies have some form of backing, whether it is USD, gold, or another cryptocurrency.
Successfully using stablecoins as a hedge against inflation depends on the reserve that backs its value. If your purchasing power through a certain fiat currency decreases, then stablecoins backed by a different reserve retain their value and offer stable prices.
However, if your stablecoin is pegged to the same currency that is experiencing inflation, then your investment might lose its value as the value of the reserve currency declines.
Another crypto that many argue could be the answer to rising prices is Ethereum. Some say it may even be a better long-term value store than Bitcoin.
Much like Bitcoin, Ethereum has seen significant growth in recent years and may experience a similar scarcity in supply over time as a result of its recent change in transaction protocol.
Still, Ethereum’s potential as a hedge against inflation is also speculative, and there is little evidence during our current economic state that it is the definitive solution to rising prices.
It’s hard to decide whether Bitcoin or Ethereum acts as a better hedge against inflation since both currencies are still relatively new. As time goes on, we will certainly be able to come closer to determining which is more effective.
Factors Supporting The Bitcoin Inflation Hedge
Even though Bitcoin is not faring as well as many expected it to during a period of high inflation, there are a few reasons you can remain hopeful that it will be a good inflation hedge in the future.
First, the limited supply of Bitcoin helps protect it from devaluation. Since its supply is limited and becoming more limited each year, the risk of inflation is reduced significantly.
Compare this to fiat currencies like USD that can be printed at a moment’s notice. There is no limit to the maximum amount of U.S. dollars that can be printed, forever impacting its purchasing power.
Global Availability And Financial Backing
Bitcoin has the added advantage of not being tied to a specific currency. In the instance of stablecoins, an asset tied to a currency experiencing high levels of inflation would be similarly impacted.
In other words, you and everyone else around the world will experience the same volatility associated with Bitcoin as opposed to varying levels of inflation as a result of individual economies.
Security And Interchangeability
Along with its limited supply and global availability, Bitcoin is also an easily transportable asset. You can safely move it from a digital wallet to an exchange like Vauld, where it is protected and insured.
At Vauld, we keep your assets safe by moving funds from your wallet to a centralized lending pool that’s insured for $100 million in BitGo, a leading digital asset trust and security company.
This means that anyone with an internet connection can securely own and trade Bitcoin during periods of high inflation, making it a viable alternative in scenarios of economic uncertainty.
Outsmart Inflation With Vauld
Although Bitcoin was designed to maintain a gold-like rate of inflation, nothing has yet proved that it is capable of protecting against rising prices in this way. Still, it’s important for crypto investors to be aware of what Bitcoin inflation means.
There are many factors contributing to the potential that currencies like Bitcoin and Ethereum have for countering inflation. But due to short histories and currency limitations, it is too soon to tell.
Whether you view Bitcoin as the ultimate hedge against inflation, an effective store of value, or just an excellent way to diversify your portfolio, the best way to make the most of your wealth-building journey is to know you’re in good hands from the start.
Along with an arsenal of security features, Vauld users get regular upgrades, the highest quality of customer service, and competitive rates on Bitcoin, Ethereum, stablecoins like Tether and Dai, and a long list of other crypto options for all of your crypto endeavors.
No matter which tokens you decide to store, you’ll start earning as soon as you make your first deposit. Sign up with Vauld today and explore new ways to protect and grow your assets.