One of the biggest stories in the world right now is record-setting inflation. Governments are seeking to hold down their inflation indexes, but prices in traditional markets are still rising dramatically each month. Cryptocurrencies therefore gain more traction from investors. Some investors take certain coins and tokens as a hedge against inflation – or digital gold, while others contend that these currencies are much riskier assets due to their volatility nature. But what is the true narrative of the relationship between Bitcoin price and inflation? Below we attempt to provide some of the most informational and helpful answers to questions about cryptocurrencies and inflation. Comprehensive explanations are available, and you just need to jump right in!
Inflationary and Deflationary Cryptocurrencies
Inflation: Inflation is an increase in the overall level of prices. Besides, we can stick to the primary definition presented by Hazlitt: “Inflation is the increase in supply of money and credit. Each individual note and coin becomes less valuable because there are more of them available. Goods then rise in price not because goods are scarcer before, but because notes & coins are more abundant.”
Deflation: Deflation refers to a general decrease in prices for goods and services, often linked with a reduction in the availability of money and credit within the economy. During deflation, the buying power of currency increases gradually. This phenomenon leads to a decline in the nominal expenses associated with capital, labour, goods, and services, even though their relative prices may remain unchanged.
Cryptocurrencies can be inflationary or deflationary depending on their native monetary policy and design. You would assess this by examining its supply dynamics, the demand incentives, their usage and whether they preserve value and stability.
If a cryptocurrency has a fixed supply, it tends to be deflationary as the currency’s value is expected to increase with rising demand over time. Deflationary tokens are effective at encouraging holding and discouraging spending, leading to increased scarcity and accelerated adoption of the token as a store of value. This gradual scarcity contributes to a continuous improvement in purchasing power over time. Moreover, a decreasing token supply acts as a safeguard against inflationary pressures coming from external factors like government policies or economic events that may lead to inflation, hyperinflation, or stagnation.
By contrast, cryptocurrencies with an unlimited supply tend to be inflationary, as their value may decrease over time due to oversupply. Inflationary tokens may promote spending and discourage hoarding, thereby enhancing their adoption as a medium of exchange and improving liquidity. A notable advantage of inflationary tokens is their flexibility, allowing adjustment of the inflation rate to suit the company’s requirements, such as for airdropping new tokens or other purposes specified by the tokenomics of the company.
Is Bitcoin inflationary?
Bitcoin was indeed designed to resist inflation or experience predictable and low inflation rates. However, Bitcoin is technically an inflationary currency. This so-called digital gold was created to mimic the stable inflation rate of gold. The currency experiences inflation as more of it is mined. However, given the Bitcoin halving, which reduces the rewards for mining by 50% every four years, inflation rates will decrease eventually.
Many may confuse Bitcoin to be deflationary because its purchasing power increases over time, but this is not true. As Bitcoin’s supply doesn’t decrease but rather steadily increases until it reaches a maximum cap of 21 million coins, it cannot be considered deflationary.
In fact, when Bitcoin reaches its capped supply, it will be neither inflationary nor deflationary. Instead, it will culminate in a constant monetary base and an unchanging supply, becoming disinflationary.
Is Bitcoin an Inflation Hedge?
Many investors view Bitcoin as a potential inflation hedge. Common justifications for this role include its capped maximum supply and decentralised nature, conferring scarcity and resilience.
However, existing theoretical and empirical studies have not reached a consensus about Bitcoin’s hedging ability. Evidence has shown that Bitcoin hasn’t really acted as an inflation hedge. Recently, bitcoin returns have become more correlated with those of broad stock market indexes. This means that when the markets go down, the Bitcoin price tends to fall too. For instance, when the FED indicated that it would raise interest rates in early May 2024, BTC’s plummeted along with stocks. But after the regulator announced a steady strategy and left its benchmark fed funds rate range unchanged at 5.25% – 5.50%, the price bounced back in minutes.
What will happen to Bitcoin in a recession?
In 2008, Satoshi Nakamoto created Bitcoin to provide the public with a currency independent of third parties or central authorities. In a recession, adverse economic effects can spread over countries with economic ties. Since Bitcoin is inherently decentralised, it can act as a recession-resistant asset. For example, while the U.S. dollar is subject to the U.S. economy factors, such as the country’s GDP, monetary policy, etc, Bitcoin isn’t limited to any one country’s loss or gain.
