Why Bitcoin is not a solution to inflation?

Author Frederik Van Lierde - Monday, July 11, 2022 📰  - Impressions: 198 

Let's dig deeper into why the crypto community believes bitcoin is a hedge against inflation and what they are missing.

Table of Contents

What is Inflation?

Inflation isn't caused by 1 factor only; in fact there are various factors that can drive inflation. Typically, inflation is a result from an increase in production costs or an increase in demand for products and services.

The Positive Effects of Inflation?

Inflation can be possitive: John Maynard Keyes, the Brittisch economist, wrote that some inflation is even neccessary to provent the paradox of Thrift. Inflation can balance the economy.

When inflation increases, consumers get incentivised to buy now the products and services they need, instead of waiting for next year when the prices will be even higher:

The incentives are not limited to consumer goods; if people have savings and the return interest is lower than the inflation rate, meaning they lose money year on year, they get incentivised to invest in higher-yield investments.

People or businesses with a high level of debt may also benefit from higher inflation rates. When borrowers have an interest rate of 2%, inflation rate is 10%, and their income increases at the same rate, the effective rate the debts are getting repaid is declining.

The Negative Effects of Inflation?

The most know negative effect of inflation is that your money is losing value, which means losing purchasing power. The dollar lost half of its value between 1980 and 2019

Effect of Inflation reduced purchasing power

Another negative effect is that inflation increases the cost of living, and when the inflation rate is too high, it will hurt the economy. Inflation firstly hurts low-income households, as they spend most of their income.

Low-skill workers are also affected, as their wages are staying the same due to the high-level competition in the industry. When there are too many workers for the same job position, the employers have great power to negotiate the salary. On top of that, minimum wages are not always following the inflation rate, so they are even worse off.

Why Printing Money Increases Inflation?

Based on the existing economical laws, when governments print more money, households and businesses will have access to more money. Because households and businesses will have more money at hand, they will spend more on goods and services.

When the supply of goods stays the same, demand is growing, and the prices of products/services will go up. This is the principle of scarcity.

The idea of "when demand goes up, and supply is limited, the price will go up" is a fundamental economic principle. Already in 1890, Alfred Marschall developed the supply and demand curve.

Why does the crypto community believe bitcoin is a hedge against inflation?

The main factor the crypto community tells me is that bitcoin has a limited supply of coins, which is 21 million coins. In contradiction with the unlimited supply of printed money.

Currently, around 19 million coins are generated, which means that the coin will become more scarce, and when the demand goes up, the price should go up. The crypto community uses the principle of scarcity.

Another explanation I get is that Bitcoin is a store of value over time, like gold. The crypto community believes that Bitcoin is an asset that will not depreciate in the long term.

Why crypto isn't a safe hedge against inflation?

During the last months, the value of Bitcoin has been falling down dramatically while inflation increased despite the scarcity.

The main error in the way of thinking by the crypto community is the fact that, even after 10 years of existence, Bitcoin simply stayed a volatile risky investment vehicle, and there is not a simple, direct way to buy and sell basic products and services.

When we look at the positive and negative effects of inflation, describe above, we see one main parameter returning. Consumers and businesses need to spend money.

To use your crypto money, because the prices are increasing, you need to exchange the crypto for fiat money, and when that is done, you enter the game of inflation as we know it.

This is even more true for lower-income households as they don't have the luxury of having extra savings to hold on.

When you see crypto only as a store of value, you are taking high risks. Crypto is unregulated, and we see more and more exchanges limiting the withdrawal limit or simply going bankrupt without any protection. When you end up with 0 crypto = 0 dollars, the inflation in the real world will hit you even harder.