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How can Crypto Protect You from Inflation?

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How can Crypto Protect You from Inflation

Over the past 13 years of its existence, the cryptocurrency industry — as well as individual coins — have taken on many roles thanks to various blockchain products. They offered a better payment system, decentralized banking, a way for artists to secure the rights of their work, and right now, the blockchain sector is working on establishing itself as a network that would represent the next stage in the evolution of the internet itself.

However, among all of those changes and benefits, the idea of the crypto industry as a way to protect people from inflation also emerged. In this scenario, Bitcoin itself is often referenced as the best way to protect people from inflation, with some even saying that it works better than gold in that regard.

What is inflation?

Inflation is the process during which the value of the operational currency, such as the USD, GBP, EUR, JPY, and alike, decreases, while the price of goods and services tends to go up. It often happens during economically challenging times, when the governments are forced to print out more money than it is needed, but the situation calls for urgency, and so it cannot afford to wait for the existing money to circle around and come back to it.

The most recent example of this was seen in 2020, when the COVID-19 pandemic took the world by surprise, sending people into lockdown, when countless businesses either shut down completely, reduced their workforce, or were forced to stop providing their services for a time.

As a result, people were instructed to stay indoors, and many lost their jobs or had to stop going to work while the business itself went into a state of hibernation. In any event, the fact is that a lot of people stopped earning money unless they were fortunate enough to be in the line of work that allows them to work from home. So, the governments had to resort to giving away money in order for the people to be able to survive such harsh conditions.

This led to printing more money in countries around the world. In traditional finance, the amount of money in circulation is decided by the central bank, and there is no limit to how much the bank can print if it decides that there is a need to do so. While at first, this resulted in relief for the people who desperately needed cash to survive, in the long-term, it is a huge problem because there is no more money out there in the world, which makes the value of it lesser than before.

This is the case with any asset, commodity, or object in general. The more of it there is, the less its worth will be. Immediately after this started happening, however, many investors started buying gold, silver, and other things that could serve as a store of value. Among them was also Bitcoin, which managed to attract even some former crypto skeptics, in addition to regular cryptocurrency supporters.

How can Bitcoin protect you from inflation?

As you may know, cryptocurrencies such as Bitcoin are decentralized. That means that there is no central authority such as the central bank that controls them. Bitcoin operates on top of blockchain technology, which is run by a community of regular people from all over the world, who contribute resources such as electricity and computing power to process transactions.

While central banks process transactions using their own private servers — the blockchain uses computers of regular people, which is similar to having servers all around the world. But, due to this arrangement, no individual or organization participating in running the network has ultimate power over it, and all decisions regarding the network need to be voted out democratically by the members of the community.

Another advantage that crypto has is the fact that it is digital money based on a code, which means that, if the code says that only 21 million Bitcoin can ever exist (as is the case), then this is a fact that cannot be changed, unless the entire community agrees on it. Putting a cap on Bitcoin and guaranteeing that it will not change ensures that people will know exactly how many coins there can ever be. There can be no printing of new coins as is the case with physical money, so its value will never decrease due to the issue of a growing supply.

In other words, Bitcoin physically cannot suffer from inflation. This makes it better than traditional money, and even better than gold. While experts have a pretty good idea about how much gold there is in the world, there is always the possibility that a new massive deposit can be found somewhere. Naturally, it would not be left alone, but mined and released into circulation, which would effectively reduce the value of gold through the increase of supply. This cannot happen with Bitcoin, which is why there is the idea of using Bitcoin as the “future gold,” meaning that Bitcoin might replace gold as a store of value.

Bitcoin is also much easier to store, send, and split into smaller units than gold, as all you need is a crypto wallet in order to manage your payments.

It is worth noting that not every cryptocurrency works like this, however. Some coins have a massive supply that consists of billions of units, as opposed to Bitcoin’s 21 million. Others do not even have a cap and can be mined indefinitely, such as Dogecoin. There are also projects that have released a massive number of coins but have also created a burning mechanism that ensures that a specific amount is permanently taken out of circulation on regular basis over a specific period of time, in order to slowly reduce the supply and increase the value. Binance Coin is a good example of that.

In other words, there are many different approaches to cryptocurrency and how its supply works, which is why not every crypto is fit to be a hedge against inflation, but some certainly are.

Does it actually work?

Over the past 13 years of the crypto industry’s existence, inflation has been fairly low in developed countries. However, once the COVID-19 pandemic hit, many professional experts switched to cryptocurrencies, alongside gold, or even foregoing gold completely in favor of crypto.

While crypto prices did crash in March 2020, this was due to the industry’s correlation with the stock market, and crypto recovered in record time, while the stocks kept crashing for months. Furthermore, the growing institutional interest led to the largest crypto rally in the history of the sector.

We had an opportunity to see crypto in action in other situations, as well. Venezuela, for example, has been suffering from hyperinflation for years, and its people turned to cryptocurrencies to try and preserve the value of their money. The same is true in other countries under sanctions that are suffering from inflation, with a huge interest in crypto even in North Korea.

Earlier this year, in the second half of February, Russia invaded Ukraine — which is a conflict that shook the world and is still ongoing at the time of writing. Many countries around the world, and almost all of them in Europe, immediately turned to sanctions, forbidding trades with the invading country and locking it off, financially, in hopes of causing economical damage that would end the war due to the crash of the Russian ruble. After all, wars cannot be waged without money.

This also led to the concern that Russia might turn to crypto to bypass not only the sanctions but the inflation itself. In other words, using crypto to avoid inflation is very much a possibility, which can be a good thing or a bad thing, depending on the circumstances. But, the short answer is that it is definitely possible, and that crypto does work well in this regard.

The problems of using crypto

So, if that is the case, then you might be wondering why don’t countries suffering from inflation simply switch to crypto right away? Well, there are several reasons for that. One of the biggest ones is volatility. The crypto industry doesn’t have assets in the real world backing it up and ensuring its price stability, so it is entirely dependent on supply and demand. Next, there is the matter of complexity and adoption. While using crypto today is fairly easy, this was not always the case, and users needed to have quite a bit of technical knowledge to handle them only a few short years back.

This requirement prevented the mass adoption of crypto. Digital currencies also pose a threat to traditional finance, as they are simply better, but also more transparent, with immutable payments, and so banks were fighting against their adoption and discouraging people from using them for years in order to stay the dominant force. Not to mention that it is an entirely new form of money and the kind that people are still largely unfamiliar with.

And, finally, being so new and different from everything that the world has known so far, the crypto industry is still not regulated. As a result, institutional investors are still hesitant to join the crypto sector, although they have been slowly doing so anyway in recent years. But even so, without proper regulations, crypto cannot be recognized as legal tender, which is why only one country managed to do it so far — El Salvador. But, even El Salvador only did it in late 2021, which is to say — mere months ago.

Conclusion

Inflation is not always bad, but if it spins out of control and enters the realm of hyperinflation, chances are that it is going to cripple the country’s economy and result in a very difficult way of living for its people. The crypto industry can help against inflation and ensure that people can still live a normal life, even if their local traditional currency is crashing.

However, there are still obstacles that ensure that it cannot be done as a result of the government’s initiative, which means that, if you live in a country that struggles with inflation — you must switch to digital currencies on your own in order to ensure your personal financial stability. The crypto industry can definitely help, but learning about it, how it works, its pitfalls and dangers, and alike, is the first step in order to be able to use it effectively and protect yourself against inflation.

Ali is a freelance writer covering the cryptocurrency markets and the blockchain industry. He has 8 years of experience writing about cryptocurrencies, technology, and trading. His work can be found in various high-profile investment sites including CCN, Capital.com, Bitcoinist, and NewsBTC.

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