April 1, 2023

In theory, Bitcoin (BTC) should serve as a hedge against inflation. It is easy to obtain, its supply is predictable, and central banks cannot manipulate it arbitrarily.

However, investors did not treat it that way. Instead, the cryptocurrency market is mirroring the stock market. why is that? Let’s dive into what prevents cryptocurrencies from serving as a hedge against inflation, and what needs to happen to make them a hedge in the future.

Cryptocurrency may be a hedging tool, but it brings inconvenience

Cryptocurrencies offer a unique solution given the lack of a centrally regulated bank. You can’t lose trust in something that doesn’t exist. Its supply is limited, so it will naturally appreciate in value. People using a blockchain with a proof-of-stake protocol can access their funds at any time while continuously earning staking rewards for their current balance. This means that the actual value of the annual rate of return is tied to economic activity on-chain through its treasury and staking reward distribution mechanisms. These properties appear to address the causes of inflation in traditional monetary systems – but some roadblocks remain.

RELATED: Is Inflation Getting You Down? 5 Ways To Accumulate Crypto With Little Or Free

First, let’s look at the reasons why people invest and hold cryptocurrencies.Most cryptocurrency holders see future The potential of these technologies, which means some of their value is not Currently present. They are speculative investments. Bitcoin has achieved decentralization, but its high energy costs remain unresolved, with most mining power still clustered in a dozen or so mining pools. Ethereum has similar problems with energy consumption and mining pool centralization.Ethereum also has a security issue — it has surpassed $1.2 billion stolen on its blockchain this year.

There is also the issue of decentralized exchanges or DEXs, which are currently not suitable for centralized exchanges. Compared to centralized exchanges, the DEX with the highest trading volume, Uniswap, has lower pricing efficiency. A simple trade of USD Coin (USDC) for $1 million in Tether (USDT) would cost over $30,000 in fees and slippage compared to execution on a centralized exchange.

These are technical problems with solutions

Of course, these issues are being addressed. Several third-generation blockchains are addressing energy consumption and decentralization head-on. Privacy is improving. Cryptocurrency holders begin to accept that their wallets will always be fully traceable, which will prove attractive to new users who were previously hesitant about the blockchain’s ultra-transparency. Projects that seek to combine the mathematical rigor of traditional finance with the native properties of cryptocurrencies are addressing DEX inefficiencies.

Related: Ronin Hacker Moves Stolen Funds From ETH to BTC and Uses Sanctioned Mixer

Mass adoption and integration are needed before cryptocurrencies can act as a bulwark against inflation. In an ecosystem that is currently struggling to establish its fundamentals, cryptocurrencies are characterized by future value. The cryptoeconomy is still waiting for applications that can take full advantage of decentralization without sacrificing quality and experience, which is especially important for widespread adoption. A payment system with a fee of $5 per transaction and frequent loss of transaction value will still not be viable.

Until top cryptocurrencies can be effectively used for real-world payments and decentralized applications provide a similar level of utility to centralized systems, Cryptocurrencies will continue to be seen as growth stocks.

Inflation is caused by a lack of trust – crypto still needs something

Inflation is not simply caused by printing more money, that is, presence The value of an asset does not automatically cause its value to decrease. Between September 2008 and November 2008, billions of dollars in circulation tripled while inflation fell.

Inflation has more to do with the public’s distrust of the central monetary system. This lack of confidence—combined with upheaval caused by corporate price gouging, pandemic relief packages and major supply chain disruptions (accelerated in part by the war in Ukraine)—has brought us into the current crisis. The massive money printing in 2021 didn’t cause inflation, but it amplified it.

Related: Has U.S. Inflation Peaked? 5 things to know

Funding alone is not an overly important issue for store-of-value currencies in terms of existence. What is stored is not necessarily part of the circulating supply. For example, gold exists in large quantities in the form of jewelry, bullion, etc., but in much smaller quantities on the commodity market. The market considering all the mined gold on the planet will have completely different prices. Because such jewelry and bullion are not traded in the market at all, they do not affect the supply and demand curve. The same applies to currencies.

Inflation is the result of losing trust in an asset’s ability to store its value over the long term. Most commodities in this world are finite, so each party knows that the supply is increasing but isn’t sure that monetary policy will automatically factor it into their prices. Inflation became a self-fulfilling prophecy.

Cryptocurrency as an inflation hedge is possible, but not in the current environment

In times of high volatility and market uncertainty, cryptocurrencies cannot be used as an inflation hedge. That said, they typically do well in stable growth environments where they easily outperform the market, and with a relatively small market cap compared to fiat currencies in their favor, they are growth stocks. The current solution to the usability problem is not sustainable due to the speculative based nature and low transaction volume. The decline of financially distressed blockchains affects the entire ecosystem, meaning potential long-term solutions are constantly being destroyed by scammers.

Related: Is Bitcoin Really an Inflation Hedge?

The more responsible and diligent the crypto community becomes, the more every sound protocol will benefit, and crypto will become a true inflation hedge. Since cryptocurrencies currently follow a growth stock model, they are a good hedge against inflation during periods of steady growth, but failed during financial crises. As cryptocurrencies grow, they will also be effective bulwarks during these downturns.

Today, caution is prudent when investing in crypto during times of market turmoil, and it is unwise to use crypto as the only tool to prop up your investments against inflation. But this will change as blockchain protocols continue to mature, and we will see cryptocurrency adoption and stability increase as inflation hedges increase. Tools are already in place.

Jarek Sirniak is the founder and CEO of Generation Lambda and a certified quantitative analyst with over 20 years of software development experience. He spent six years at Citadel Securities and UBS Trading Systems, where he developed a range of novel trading systems and trading-related software platforms, while leading multidisciplinary teams.

The views expressed are those of the author alone and do not necessarily reflect the views of Cointelegraph. This article is for general informational purposes only and is not intended and should not be considered legal or investment advice.

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