Can cryptocurrencies protect against inflation?

Scarcity makes the store of value — gold or bitcoin — resistant to inflation. Therefore, bitcoin is often referred to as “digital gold”. Its total number will not exceed 21 million coins, which gives it an advantage over fiat currencies, the supply of which is unlimited.

Other cryptocurrencies, such as Ethereum, have a different inflation protection mechanism called burning. But this is not a new idea. In traditional economics, there is such a thing as share buyback. While buybacks and coin burns are not exactly the same thing, the concepts are very similar.

The crypto community has expanded significantly in recent years, and many of its members have pinned their hopes on cryptocurrencies as a means that will save their savings. RBC Crypto experts told how realistic it is to protect yourself from inflation with the help of digital non-state currencies today.

 

Cryptocurrency, as a tool for protecting against inflation.

“Given daily issuance relative to a cryptocurrency already in circulation, BTC and ETH domestic inflation is small (1.75% and 0.5% today) and does not compare with fiat inflation, which is now reaching double digits. Therefore, for those market players who are looking for a tool to store value, cryptocurrency is the best tool in the long run.”

Despite this, it is impossible to call bitcoin and other crypto assets the best tools against inflation, the expert emphasized. He noted that there are difficulties in using cryptocurrencies, which reduce the demand for them as deflationary assets, namely:

  • High volatility of cryptocurrencies;
  • Lack of regulation;
  • Lack of reliable custodians.

“These and some other aspects limit the amount of funds that institutions are willing to place in cryptocurrencies in order to protect them from inflation in fiat currencies. In other words, the risks of cryptocurrencies are too high to speak about the unambiguous use of digital assets as a tool against inflation,” the specialist explained.

According to him, from the point of view of emerging economies, cryptocurrency can be a tool to help preserve value. However, a significant drop in cryptocurrency rates against USD (as well as against RUB) reduces the advantage of BTC and ETH as low-inflation assets: as a result, a person will still go “to the cash”, and not remain in the crypt, and even if inflation does not eat his money, then he will lose some of his assets amid a drop in the capitalization of the crypto market, Pershikov warned.

“So, technologically, cryptocurrencies are indeed a tool against inflation, but in reality there are a lot of “buts” of such use.”

A senior analyst at BestChange added that it is actually quite difficult to protect against inflation with the help of cryptocurrencies. The main property of a protective asset should be relatively low volatility, which no other cryptocurrency project can boast of, with the possible exception of stablecoins – hybrid assets.

“If we consider cryptocurrencies solely as long-term investments, then on average they can protect against inflation and even bring income significantly higher than traditional conservative stock market instruments. But still, this does not make them a defensive asset. After all, for example, for investments shorter than two years, there are more time periods that would bring losses than profitable scenarios,” the expert explained.

He attributed this to the fact that any rapid growth in the capitalization of the crypto market is replaced by a long-term deep correction. For example, from November 2021 until today, bitcoin has lost about half in price – about 56%, and the market, on average, has lost even more.

“Stablecoins with their subsequent investment in various DeFi lending and investment protocols, directly or indirectly, can be called reliable protection against inflation. For example, centralized crypto exchanges as an intermediary allow you to earn about 10% per annum in foreign currency, which is very good by the standards of the traditional market,” the analyst said.

He added that if we consider investments directly in DeFi, then under certain conditions it is possible to achieve 50% or even more than 100% per annum, with different risks of investment strategies. But the main option here is to provide liquidity on decentralized exchanges.

According to experts, it should be taken into account that an asset used to protect against inflation must have good liquidity – that is, ease of conversion into the national currency and vice versa. In modern realities, conditions for investors in this direction have also deteriorated significantly – despite the fact that the methods of exchange continue to be available, various legislative initiatives within the country and Western sanctions have significantly reduced the number of available options, and the investment climate has forces to prepare only for the deterioration of the availability of cryptocurrencies for citizens, the expert warned.

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