Cryptocurrency and inflation. These two were supposed to have a close relationship — when inflation got hot, crypto was supposed to get hotter. The result being potential protection for the buying power of your money.
And yet, as inflation has increased at the fastest pace in decades, crypto has been so volatile this relationship has come into question. It’s got some industry analysts thinking about the role cryptocurrency plays in a world with persistently high inflation.
The Connection Between Crypto and Inflation
Many fans of cryptocurrency often think of it as a digital substitute for the US dollar, and in some ways, it is.
Not every coffee shop is accepting Bitcoin or Ethereum, but crypto is growing as a method of payment. Several big-name retailers (and popular e-tailers) already accept bitcoin, and it’s quite possible the number of businesses accepting digital currencies is only going to grow.
If inflation erodes the value of a dollar over time, people often look for assets that can consistently outgrow the increase of inflation. Crypto’s big moves in a year like 2021 had some people feeling digital assets could serve that purpose. A lot of investors already do this with gold, commodities and other investment asset classes. Instead of putting money in traditional and alternative investments to build and store wealth, an investor might purchase cryptocurrency in hopes it increases in value — making it less vulnerable to the fluctuations of the U.S. dollar.
What we’ve learned over the past few months is that big swings in crypto mean it lacks the consistency needed to outpace inflation. For instance, Bitcoin’s value significantly decreased in 2021 at the same time consumer prices began heating up — and it saw another decrease at the end of 2021 that’s continued into 2022.
This also signals Bitcoin is so far unreliable when it comes to being an everyday currency. When the value of a digital coin swings 10% one direction or the other in a matter of days, it’s hard to see it as trustworthy tender for the average person to use it to make purchases. This volatility means it remains risky not only as a currency, but as an investment asset class, too.
Could this inflationary period be different?
This bout with inflation looks different from history. Much of the recent inflation has been from pandemic-related quirks, like the rise in commodity prices, supply chain disruptions and labor force changes. Demand for goods has also increased as we were stuck at home for so long. Yet it’s already lasted longer — and been more severe — than many financial experts expected.
Classic and better-understood inflation hedges (such as gold) haven’t worked well in this environment, either. Typically, when inflation increases, you would see the value of hedge investments increase as well. Yet it hasn’t been that simple in this current climate.
And unlike other instances of rising prices, inflation hasn’t dampened growth much, which is benefitting the U.S. dollar. With its stability, you may have more confidence in it retaining value versus its hedge investments, including cryptocurrencies.
Don’t count on crypto.
Some investors are already using Bitcoin and other cryptocurrencies as a hedge against inflation. This could prove to be a savvy move, but that remains to be seen for now because it is such a youthful investment asset class. Its risk is less understood and more difficult to compare with other securities.
Simply put, crypto’s past is too brief to predict its future performance.
For now, cryptocurrency remains an unpredictable investment opportunity. If you own Bitcoin (or another crypto) as part of your diverse investment strategy, set specific performance goals for it. This will guide your actions when it crosses a specific price. That way, you’ll avoid emotional investing (trying to ride it to the top, for instance).
Cloudy, With a Chance to Transform the World
If you purchased crypto because you believe in the transformative power of digital currency and blockchain technology, this could be the beginning of an exciting future. There’s no denying that the underlying technology of blockchain, which verifies crypto transactions, has the potential to change our daily financial transactions — and beyond. But whether its innovation is a definitive hedge against inflation? That remains to be seen.
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Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.
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