Cryptocurrency and High Inflation
Investors have been monitoring the financial markets over the past six months. They are well aware of the threat posed by the ever-rising inflation levels. They know the damage this will cause to economic growth, personal wealth, and consumer spending habits.
According to the latest release of the Consumer Price Index (CPI), a leading inflation indicator, inflation is currently at a 40-year high.
With such a drastic rise in inflationary pressures being compounded by geopolitical conflict, supply chain blockages, weakening fiat currencies, and residual impacts from the pandemic, investors are rightly concerned about the short-term effects on their investments.
In this article, we will examine the impact this has on investment portfolios. We will discuss how we might be able to protect against the eroding effects of this on our wealth using crypto. Let’s get started!
What is Inflation, and Why is it Here?
It refers to the loss of purchasing power our money endures due to the increased supply of money currently in the economic system. As the money supply increases, the value of each unit decreases.
Several factors can cause inflation. It's up for debate as to what catalysts (or combination of triggers) have led to the record-high levels we are currently seeing.
Many commentators believe the quantitative easing program has primarily caused this inflation that the Federal Reserve (and other central banks) embarked on during the pandemic.
Others argue it's been compounded by both geopolitical tensions and supply chain blockages.
Indeed, even President Joseph Biden recently noted in a public statement that he believed inflation was mainly due to the decisions made by Russian President Vladimir Putin. Combining these factors has led to the record-high inflation we are currently experiencing.
How Inflation Impacts Traditional Portfolios
As inflationary pressures continue to rise, central banks are inevitably compelled to take action to combat runaway cost. The most potent weapon central banks have to help lower inflation is to raise interest rates.
By raising interest rates too quickly, this could cause another crypto winter and lead to another recession.
Unfortunately, the prospect of multiple raised interest rate hikes sent the financial markets into a multi-month-long decline. This has lead to the indiscriminate compression of future cash-flow-dependent companies.
Naturally, this has had a devastating impact on many investors' portfolios currently in high P/E stocks, such as high-flying NASDAQ tech stocks. Investors following traditional investment advice of wealth managers by allocating 40% of their portfolio to bonds, have performed poorly with rising rates.
Many investors are exploring the digital asset market to protect themselves from further portfolio losses caused by rising inflation and interest rate uncertainty.
Why is Cryptocurrency a Hedge Against Inflation?
Digital assets represent a new and exciting frontier in the investment landscape.
Although they remain a largely speculative investment opportunity, many investors are beginning to look to digital currencies seriously. The reason is to protect themselves from the inflation currently eroding their fiat currency wealth.
An inflation hedge is an asset that increases in value as inflation rises. By investing in a method to combat inflation, an investor's portfolio should remain stable. The hedge should continue to increase in value as the rest of the portfolio decreases.
Historically, the premiere hedges were precious metals such as gold investing. For decades, investors included gold in their investment portfolios to stabilize their wealth against possible macroeconomic shifts or changes in monetary policy.
However, with the development of Bitcoin in 2009, many investors are now wondering whether Bitcoin would be a more effective method to resist inflation.
Is Gold or Bitcoin a Better Hedge Against Surging Inflation?
The hallmark of an inflationary hedge is a fixed supply. As discussed above, one of the root causes of rising prices is that the money supply within an economy has increased. A hedge against rising inflation will be an asset of value that enjoys a fixed supply.
Both Bitcoin and gold have a fixed supply. Naturally, there is a limited amount of gold on Earth to be mined and processed. Similarly, only 21 million Bitcoins exist, and it is impossible to create more. Both Bitcoin and gold meet the basic requirements for a hedge, but which is the better option?
Long Track Record
Unlike Bitcoin, gold has the benefit of having acted as a hedge for decades. It is a tried-and-true asset that has been considered a store of value for thousands of years.
Over long enough periods, gold has proven time and time again that it provides protection against the effects of inflation.
Many investors still choose to invest in bitcoin (BTC) despite this. Why might this be the case? For many, it's considered a more durable store of value than gold, with the added benefit of potential for massive price appreciation.
At the time of writing, BTC is up over 500% from the March 2020 lows caused by the pandemic. Many investors believe that it stands a greater chance of protecting their wealth and growing it over time. And they consider BTC the best cryptocurrency to invest in for wealth building and as an retirement alternative investment class.
In addition to capital appreciation, Bitcoin affords investors the ability to pay for goods and services. It also provides portability and can transfer value to one another through the Bitcoin network.
Ultimately, it can be argued that gold is the safer choice when selecting your hedge. It is a tried and trustworthy store of value. Gold has a long history of protecting investors from the effects of rising cost over extended periods.
However, given the 12-year track record Bitcoin has enjoyed and the possibility of further growth in the future, it would be foolish to disregard Bitcoin as a hedge.
Anyone who invested in Bitcoin over the last five years would have performed considerably better than those with a more gold-centric portfolio. Where do you want to be in five years? Investing in BTC is easy, and the journey to get started isn't too late!
To prevent losing money in one's wealth portfolio, a strategy of allocating both gold and crypto assets to your wealth portfolio combines the best of both worlds to help safeguard your future retirement during times of hyperinflation.