With inflation rates soaring in many countries around the world, sensible investors are looking for alternative opportunities that are less susceptible to decreases in value over time. Some consider cryptocurrencies, and Bitcoin in particular, to be an ideal solution, thanks in large part to its scarcity and the rate at which its value has increased over time.
In this AAG Academy guide, we’ll look at inflation and what it means, why investors need to hedge against it, and why many believe Bitcoin to be a great option.
Inflation in economics is the name we use to describe two key things: A rise in the prices of goods and services and a decline in the value of money. Inflation is always happening since currencies are constantly losing value over time. That’s why your favorite candy bar or soda costs a lot more today than it did when you were a kid.
Most economists believe that some level of inflation is a good thing for the economy, however, when the rate of change rises too quickly — as we are currently seeing in many countries around the world due to a number of economic factors — it can have a detrimental effect. Especially when the costs of essential goods and services rise faster than anticipated.
The rate of inflation aims to measure the impact of these changes on a diverse group of products and services, rather than just one or a certain group of things, over a period of time. This provides a clearer picture of its overall impact, since we rely on a wide range of basics and essentials to live a comfortable life, such as water, food, shelter, energy, and transportation.
One of the biggest causes of inflation, according to most economists, is when the growth of a nation’s money supply outpaces its economic growth. This forces a nation’s monetary authority — in most cases its central bank — to take steps to manage the money supply and adjust credit rates in an effort to ensure that the economy continues to run as smoothly as possible.
As we touched upon in the section above, one of the biggest effects of inflation is a rise in the price of goods and services. Almost everything, from basics like water, food, and energy, to “non-essentials” like smartphones and video games, become more expensive at a faster rate than usual. However, in most cases, our salaries and pay rates do not keep up.
For instance, the rate of inflation may be 6%, which can cause a significant rise in the cost of things like electricity, fuel, and mortgages. But our salaries may rise by just 3-4% every year, if we’re lucky. Over time, goods and services become less and less affordable. This is the reason why it’s significantly more difficult to buy your first home today than it was 30 years ago.
Furthermore, inflation causes existing loans and mortgages with variable interest rates to become more expensive — since their repayments rise in line with the rate of inflation — and it lowers the value of any money you have saved, including your pension, because that money no longer stretches as far as it once did and therefore your purchasing power is reduced.
We’ve already mentioned some examples of how inflation can affect certain aspects of our lives, and we only have to look at what’s happening in the world right now to see it in action. The ongoing cost of living crisis that many countries are experiencing has seen the price of countless essentials — including energy, fuel, and food — rise significantly across the board.
In the United States in June 2022, the consumer price index, which measures the average change in prices over time, increased to 9.1% — its highest level since November 1990. Gas prices exceeded $5 per gallon as the price of oil mounted, thanks in large part to Russia’s invasion of Ukraine, which has greatly impacted the supply of many commodities.
Another severe example of inflation in recent history is the 2008 financial crisis, during which the cost of most products and services increased substantially and oil prices hit an all-time high, while property values fell by nearly 20%. During this time, many workers lost their jobs as companies folded, unable to keep up with soaring prices.
Given that the value of many investments, including savings, pensions, and treasury bonds, falls as a result of inflation, it makes sense to look for investment opportunities that are largely immune to inflation rates and declining purchasing power. These are options that either maintain or even increase in value during inflationary cycles, thereby increasing your purchasing power.
If you put $5,000 into a savings account today and you don’t touch it for 10 years, it will have increased a little, thanks to interest. However, it won’t have increased anywhere near as quickly as inflation, and so when it is withdrawn a decade later, what you can do with that money is considerably less than what you might be able to do with it today.
Hedging against inflation involves putting your spare cash into alternative opportunities that aren’t negatively affected by inflation. This might include buying stocks, acquiring real estate or putting money into real estate investment trusts (REITs), investing in treasury inflation-protected services (TIPS), or perhaps even buying cryptocurrency.
Bitcoin is widely considered an inflation-immune cryptocurrency because, unlike fiat currencies that become less and less valuable as the years go by, the price of BTC has risen exponentially over time. Even today, during an incredibly bearish market that has seen the price of all cryptocurrencies fall considerably, BTC is still worth a lot more than it was five years ago.
For example, if you had purchased five BTC in 2017, it would have cost you approximately $5,000. However, the same amount of BTC today would sell for just under $84,000. And should the value of Bitcoin return to its all-time high — which is likely to happen again at some point in the future given past performance — five BTC would be worth an incredible $325,000.
One of the reasons for this is that Bitcoin, unlike fiat currencies and most other cryptocurrencies, is not unlimited in its supply. Around 18 million BTC has been minted to date, and when that figure reaches around 21 million, which is expected to happen by the end of 2078, it will be impossible to mint any more. This scarcity should make it even more valuable over time.
Of course, cryptocurrencies are a lot more volatile than other investments, which means that you can expect their value to fluctuate more regularly and more significantly than something like stocks. History has shown us, however, that no matter how far the value of Bitcoin falls during bearish periods, it tends to bounce back, sometimes to another new high.
It should be noted, however, that not everyone considers Bitcoin and other cryptocurrencies to be inflation-immune investment options. During the current climate, cryptocurrency as a whole has suffered a significant decline in value, much like most other currencies and many industries. Investors have less cash to play with, and therefore demand is reduced.
The debate about whether or not cryptocurrency is a good hedge against inflation is far from over, but there are some investment alternatives that may be safer bets, such as stocks, real estate, and treasury inflation-protection services.
Many consider Bitcoin to be a good inflation hedge, but recent economic events suggest it may not be as immune as initially anticipated. Like other currencies and industries, Bitcoin’s value has fallen considerably during the ongoing cost of living crisis.
A rise in inflation means that the cost of living increases. Goods and services we rely on for a comfortable life become more expensive, and we have less cash to spare. This causes demand for Bitcoin to fall because fewer people are looking to invest in it.
This article is intended to provide generalized information designed to educate a broad segment of the public; it does not give personalized investment, legal, or other business and professional advice. Before taking any action, you should always consult with your own financial, legal, tax, investment, or other professional for advice on matters that affect you and/or your business.
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