One feature that has drawn investors to cryptocurrencies, notably Bitcoin, is the belief that they are more resistant to inflation than fiat currencies.
Cryptocurrency and inflation were meant to be linked. When inflation increased, crypto was supposed to increase even higher. Despite this, as inflation has increased at the fastest rate in decades, crypto has been so volatile that the relationship has been put into question.
In this article, we will talk about inflation and how it impacts cryptocurrencies.
What is Inflation?
Inflation is the loss of value of currencies over time, resulting in higher costs for consumer goods.
Most economists think that some degree of inflation is beneficial to the economy. The U.S., for example, has issued far more money than consumers require for decades. On the other hand, Bitcoin has risen in value much faster than the USD has fallen in value, rising from relatively low in 2010 to over $20,000 in late 2020. Because Bitcoin is such a volatile market, it has witnessed spectacular rises and falls, but the overall trend has been upward. As a result, Bitcoin has become a popular hedge against fiat currency inflation.
Bitcoin is designed to resist inflation because its supply is limited and known. There will only ever be 21 million Bitcoins, and the quantity mined is reduced by half every four years.
What Causes Inflation?
Below are two main types of inflation and what causes them.
Demand-pull Inflation
Demand for a product or service increases while the supply stays constant, which is known as demand-pull inflation. This produces scarcity, which drives up prices.
People’s and firms’ earnings increase when the economy is performing well, creating competition. As a result, producers are more likely to increase their prices. A rapid increase in the popularity of a product can also produce demand-pull inflation on a limited scale—for example, sanitary masks.
When COVID-19 first came out, the demand for face masks skyrocketed. However, mask supply did not increase at the same rate, resulting in a shortage. Mask prices skyrocketed as a result of scarcity and continuously increasing demand.
Cost-push Inflation
Cost-push inflation occurs when the supply of essential goods and services decreases but demand stays unchanged.
If these products have no suitable substitutes, they will become scarce, and their prices will rise. Unpredictable events, such as a pandemic, production limitations, and other issues are all driving factors for cost-push inflation.
Consider the oil price model. Whenever an international agreement regulating oil production is finalized, international oil producers must usually adjust their protocols. Despite the global event, there is still an oil demand. This usually results in a drop in oil supply (scarcity) and an increase in prices.
Inflation and Cryptocurrencies
A high inflation rate for fiat currencies may encourage people to invest more in cryptocurrencies since the dollars or euros they put in a savings account are slowly losing value.
Bitcoin and other cryptocurrencies provide an alternative for investors. The Bitcoin market’s economics are complex. However, several qualities built into the digital currency can help it avoid inflation. Governments cannot control Bitcoin by changing interest rates or issuing additional money to meet policy objectives. Just like gold and other sources of value, Bitcoin is expected to rise in price during difficult times.
One element to establishing an inflation-resistant store of value is scarcity. There will never be more than 21 million Bitcoin in existence. Approximately 19 million of them have been mined as of today. Miners process a new block every 10 minutes, and 6.25 Bitcoin is added to the network. By 2024, the mining reward will have dropped to 3.125 Bitcoin, and it will drop by half every four years until all of them have been mined. This process is differently known as Bitcoin halving.
Frequently Asked Questions (FAQs)
What are the effects of inflation?
Inflation can have a number of effects on the economy. For example, if inflation causes a country’s currency to fall, this might help exporters by making their products more affordable when prices are in other currencies.
On the other hand, this can harm importers by raising the cost of foreign-made products. Higher inflation might also increase spending since customers want to buy things products prices climb. Savers could see their savings losing value, limiting their ability to spend or invest in the future as such.
What are the main causes of inflation?
There are a lot of factors that cause inflation. The two main factors are Demand-pull Inflation and Cost-push Inflation.
Takeaways
- Inflation refers to the loss of value of currencies, resulting in price increases.
- Two main factors cause inflation: Demand-pull and Cost-push inflation.
- Demand-pull inflation is caused when the demand for a product stays the same.
- Cost-push inflation is caused when the supply for a product decreases, but demand stays the same.
- One element to establishing an inflation-resistant store of value is scarcity.
