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There has been a resurgence in inflation. India’s annual inflation rate has been rising for the past five months, and it’s the same situation in many other countries. This has led to an increase in the number of people seeking methods to safeguard their wealth against inflation, and cryptocurrencies like Bitcoin appear to be the ideal solution.
Bitcoin has shown to be an effective inflation hedge in the short period, it has been in existence. It has provided booming profits and is even being referred to as digital gold. Recall the days when gold was one of the only commodities individuals used to safeguard their purchasing power against the dwindling purchasing power of fiat currencies.
But why is Bitcoin being recommended as a hedge against inflation, and can it actually balance the depreciating value of conventional currencies?? Let’s find out.
Inflation: A Basic Overview
To put it simply, inflation is the growing cost of goods and services. To put it another way: When prices go up, the purchasing power of the people goes down. As a result, products and services that would have cost less in the past now require more fiat currency to be purchased. For instance, a chocolate bar that cost 20 rupees two years ago is now 30 rupees. Inflation is to blame.
Various macroeconomic and microeconomic factors might contribute to growing inflation in a country. However, most analysts believe that prolonged inflation happens when there is an increase in the amount of fiat money in circulation that does not correspond to the country’s economic development.
In most countries, the country’s central bank is in charge of regulating inflation. It monitors the supply of fiat money in circulation and sets credit limitations for the good of the national economy.
How can a hedging strategy protect against inflation?
In an ideal world, an inflation hedge would increase in value even as the purchasing power of fiat currency decreases. Gold and real estate have long been typical inflation-protection investments. During periods of inflation, these assets often held their value or even gained in value. You can safeguard your funds against inflation’s devaluation by investing in these types of investments.
However, there has been a continuous decrease in investor interest in gold. It is still a good long-term investment, but the profits are no longer as high as they once were. In addition, moving and storing it is a hassle.
The real estate market has also been hit hard, particularly in the wake of the 2008 recession. It’s also quite expensive to get started. Therefore, only a small number of people can afford to do so. To protect themselves from inflation, consumers were obliged to hunt for other assets that may serve as a hedge in the absence of traditional possibilities. This is where Bitcoin comes into play.
So how can Bitcoin excel in areas where a well-established asset like Gold couldn’t?
To keep it simple, I’ll discuss three primary reasons why Bitcoin is a better hedge against inflation than gold.
Bitcoin isn’t bound to any one currency or economy
Bitcoin, like gold, is not bound to a certain currency or economic system. Neither is it controlled by a limited set of corporations or stakeholders. As a result, it is a worldwide asset class that reflects global demand.
During periods of rising inflation, investors must take on more risk to counterbalance the drop in asset prices. For example, a dividend yield of 3% may be used to augment retirement income. But if inflation is 6%, it’s not good enough.
S&P 500’s long-term return is somewhere between 7% and 8% each year, which is barely greater than the current inflation rate. However, the S&P 500 has yielded much more than its average during the past decade. The drawback of these tremendous returns is that the valuations are now considerably higher than they were in the past. In order for investors to obtain a return of more than 6%, there are few alternatives other than investing in US equities, even at higher valuations. But in terms of risk/reward, the stock market in the United States appears to be the best out there.
Bitcoin may be a superior alternative to stocks since it avoids many of the political and economic concerns connected with the stock market. When it comes to diversifying one’s financial resources away from only domestic sources, Bitcoin and other cryptocurrencies fit the bill.
Bitcoin’s supply is finite
The total number of Bitcoins (BTC) that may be created has been capped at 21 million by an algorithm. As of 2022, there are around 19 million BTC in existence. In other words, within 12 years of the cryptocurrency’s inception, 90% of the Bitcoin that could be mined is already in circulation.
Inflation happens when the government or the central bank continues to print currency notes at an excessive rate, resulting in an overabundance of money. As defined by economic theory, inflation occurs when the money supply expands at a higher rate than the real output of goods and services. This is because consumers now have more money to spend on the same quantity of items, resulting in an increase in prices.
However, with Bitcoin, pre-set limitations on the amount of Bitcoin in circulation ensure that there is no excess supply, which helps to keep inflation in line. In addition, the digital coin’s yearly mining reward drops by 50% every four years on average. With the current supply plan, Bitcoin’s yearly production rate is around half of gold’s and is expected to continue to decline, making it more valuable and making it more difficult to get.
Bitcoin is a convenient means of storing value
Bitcoin, like gold, is durable, readily interchangeable, safe, and limited in supply, much like gold. However, Bitcoin differs from gold because it can be carried, transferred, and is arguably more decentralized. The majority of the world’s gold supply is held by sovereign states such as the United States, China, Germany, and other European countries. In theory, anyone in the world may keep and secure their Bitcoin considerably more readily than gold.
Those who believe gold is a valuable metal and Bitcoin is a Ponzi scheme may claim that the two are indistinguishable from each other. However, Bitcoin’s blockchain technology can be put to use in real-world scenarios. As a currency, Bitcoin has few practical uses in industrialized countries with relatively stale fiat currencies of their own. However, in nations prone to hyperinflation and political unrest, Bitcoin is a superior medium of exchange.
So can Bitcoin work as a hedge against inflation?
I say Yes. Statistics show that Bitcoin has performed far better against inflation than assets such as gold, real estate, and equities.
If you’re looking to hedge against inflation, Bitcoin is a great choice, but you’ll need to keep an eye on things like the regulatory landscape. When compared to traditional assets like gold, real estate, equities, and so on, the odds are much better when holding value in Bitcoin.
Underlying qualities such as restricted supply and decentralization drive Bitcoin to a privileged situation as an asset that can keep inflation at bay.
Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
