Inflation has risen once more. The annual inflation rate in India has been rising for five months in a row, and it’s a similar tale in many other regions of the world. As a result, individuals are seeking for methods to preserve their money from the depreciating effects of inflation, and cryptocurrencies such as Bitcoin appear to be the perfect solution.
Bitcoin has performed admirably as an inflation hedge in the short period it has been in existence. It has produced explosive returns and is even referred to as digital gold. This dates back to when gold was one of the only commodities people used to hedge against the declining purchase power of fiat currency. But why is Bitcoin being marketed as an inflation hedge, and can it truly compensate for the declining value of conventional currencies? Let us investigate
Inflation, in a nutshell, refers to rising costs for products and services. When prices rise, people’s purchasing power decreases. As a result, more fiat currency is required to acquire products or services that would have cost less previously. For example, a chocolate bar that cost 20 rupees two years ago now costs 30 rupees. This is because of inflation.
Inflation in an economy can be caused by a variety of macro and micro factors. Most analysts agree, however, that continuous inflation develops when the amount of fiat currency in circulation exceeds the country’s economic growth.
In most cases, a country’s central bank is in charge of keeping inflation under control. It controls the supply of fiat money in circulation and sets credit limitations to ensure the national economy’s health.
How does an inflation hedge work?
A hedge against inflation should ideally rise in value even while the purchase power of fiat currency declines. Historically, gold and real estate were the go-to investments for inflation protection. During inflationary eras, these assets usually retained and even gained in value. You successfully safeguard your funds from the depreciating impacts of inflation by investing in these assets.
However, investor interest in gold has been steadily declining. While it is still a good long-term investment, it does not provide the same returns as it once did. Furthermore, it is extremely difficult to transport and store.
Real estate has also suffered, particularly following the 2008 market meltdown. It also has an extremely high entrance fee, limiting investment to a small number of people. People were obliged to hunt for new assets that may act as a hedge against inflation since traditional options no longer provided the same level of protection. Here comes Bitcoin!
How can bitcoin function as an inflation hedge?
The restricted quantity of coins is the fundamental feature that makes bitcoin a hedge against inflation. When Satoshi Nakamoto invented Bitcoin, he included a hard limitation in the source code that limited the number of bitcoins in circulation to 21 million.
Since then, around 19 million coins have been created, with barely 2 million remaining. No one can update the bitcoin source code to boost supply. This would result in the creation of an entirely new blockchain.
As a result, with no extra supply, the coins that currently exist will soon become rare, raising demand and, as a result, increasing the asset’s price.
In theory, it should be an excellent inflation hedge. It is a rare item due to its restricted availability. It is fungible, which means that it may be traded for another without losing value. It is also easily available, widely accepted, and has demonstrated admiration.
However, a variety of variables have resulted in severe price volatility. Bitcoin grew in popularity in late 2017 before plummeting in late 2018. Similarly, it reached an all-time high in 2021 before plummeting the following year.
-Rudra Prasad Ghosh