It is no secret that we are living in a time of inflation which is causing the cost of living to soar and the price of consumer goods to surge upwards. But, what exactly is inflation? And more importantly, how does inflation affect the cryptocurrency market?
In this article, we reveal everything you need to know about inflation as a crypto trader.
What is inflation?
Inflation is defined as “a sustained increase in the general price level of goods and services in an economy over a period of time”.
In simpler terms, inflation occurs when there is more money in circulation chasing after fewer goods and services which results in a rise in prices.
How does inflation happen?
There are two main types of inflation: Demand-pull inflation and Cost-push inflation.
Demand-pull inflation happens when there is too much money chasing too few goods. This situation arises when the economy is growing at a faster rate than the supply of goods and services which causes demand to outstrip supply and push prices upwards.
Cost-push inflation, on the other hand, occurs when the cost of production rises which in turn, causes prices to increase. This can be due to a number of reasons such as an increase in raw materials costs or wages.
What are the effects of inflation?
Inflation has a number of effects on both the economy and individuals.
On a macroeconomic level, inflation can cause problems such as:
Redistribution of Wealth – inflation benefits debtors as they can repay their debts with cheaper money while it hurts creditors who are repaid in money that has less purchasing power.
Uncertainty – inflation can lead to economic uncertainty as businesses find it difficult to predict future costs and consumers become hesitant to spend money knowing that prices will be higher in the future.
Deflationary Spiral – if inflation is not managed properly, it can lead to a deflationary spiral where prices continue to fall as people hoard money anticipating further price drops. This can lead to a decrease in demand and output which further pushes prices down and creates a vicious cycle.
On an individual level, inflation can have the following effects:
Reduced Purchasing Power – as prices increase, the same amount of money will buy you fewer goods and services which effectively reduces your purchasing power.
Difficulty Planning for the Future – inflation can make it difficult to plan for the future as you never know how much prices will increase by. This can lead to financial insecurity and stress.
Decreased Savings – inflation can eat into your savings as the value of your money decreases over time.
How does inflation affect the cryptocurrency market?
Inflation has a direct effect on the cryptocurrency market as it affects the purchasing power of crypto assets. When the general price level of goods and services in an economy rises, the same amount of crypto will buy you fewer goods and services. This is because cryptocurrencies are not immune to inflationary pressures.
The main way that inflation affects cryptocurrencies is through its impact on the US dollar. The US dollar is the world’s reserve currency and is used to price most major cryptocurrencies. As such, when the value of the US dollar decreases, the prices of cryptocurrencies also tend to decrease.
How to trade during times of inflation
If you’re planning on trading cryptocurrencies during times of inflation, then it’s important to take into account the following factors:
- The inflation rate of the country where the cryptocurrency is traded.
- The inflation rate of the country where the cryptocurrency is mined.
- The correlation between the cryptocurrency and the US dollar.
You should also keep an eye on economic indicators such as GDP growth, unemployment, and consumer price index (CPI) as they can give you an idea of how inflation is affecting the economy.
It’s also important to have a diversified portfolio that includes both fiat currencies and cryptocurrencies so that you can hedge your bets against inflation.
And lastly, don’t forget to set stop-losses and take profits at regular intervals to protect your capital.
Can crypto hedge against inflation?
Cryptocurrencies have the potential to hedge against inflation but they are not completely immune to it. This is because the prices of cryptocurrencies are still largely influenced by the US dollar.
That being said, there are a few ways that cryptocurrencies can hedge against inflation:
- Bitcoin, the most popular cryptocurrency, has a limited supply of 21 million which makes it deflationary in nature. This means that as demand for Bitcoin increases, the price will go up since there’s a limited supply.
- Ethereum, the second largest cryptocurrency by market capitalization, is also deflationary as its supply is capped at 18 million ETH per year.
- Cryptocurrencies that are not mined (e.g. Ripple, Stellar, EOS) have a set supply and are not subject to inflation.
- Some cryptocurrencies, such as Dash and Monero, use a proof-of-work algorithm which makes it difficult for new coins to be created, thus limiting supply and inflation.
So, while cryptocurrencies can hedge against inflation, they are not completely immune to it. It’s important to keep this in mind if you’re planning on trading during times of inflation.
If you would like to add crypto assets to your portfolio to hedge against inflation, we recommend using SokuSwap. SokuSwap is a completely decentralized platform that is easy to use and has an active community of traders and experts from which you can ask for support.
Frequently asked questions
What are the 3 main causes of inflation?
The 3 main causes of inflation are:
Demand-pull Inflation – This happens when there’s an increase in demand for goods and services in an economy. This can be due to population growth or an increase in government spending.
Cost-push Inflation – This happens when the cost of factors of production such as labor or raw materials increase. This can be due to an increase in the price of oil or a decrease in the supply of labor.
Asset Inflation – This happens when the prices of assets such as stocks, real estate, or cryptocurrencies increase. This can be due to an increase in investor demand or a decrease in the supply of assets.
What happens to crypto during inflation?
The prices of cryptocurrencies are largely influenced by the US dollar. As such, when the value of the US dollar decreases, the prices of cryptocurrencies also tend to decrease.
That being said, some crypto tokens can hedge against inflation.
How is inflation measured?
Inflation is measured by the Consumer Price Index (CPI), which is a basket of goods that represents the prices of goods and services in an economy.
The CPI is used to calculate the inflation rate, which is the percentage change in the CPI from one period to another.