Inflation is a critical factor that can affect the crypto industry, as it directly affects the value of different currencies. Inflation is a sustained increase in the price level of goods and services. Inflation occurs when there is an increase in the supply of money and credit relative to the number of goods and services available for purchase.
Inflation causes prices to rise as people have more purchasing power. As a result, goods and services become more expensive over time because there is less value for each currency unit.
The crypto industry and inflation
The digital asset landscape is constantly evolving. For example, in the crypto industry, inflation refers to the continual introduction of new coins into circulation.
For example, Bitcoin’s aggressive deflationary protocol proposes a limit of 21 million coins and a gradual decrease in the overall minting of new coins with each halving event. In 2021, the circulating supply was 18.7 million but with a current inflation rate of 1.8%, which will decrease with every halving event; analysts slate the next one for May 2024. This schedule ensures that new bitcoins will steadily become more scarce, and their purchasing power increases as demand remains high, yet supply levels decline even further.
Ethereum‘s inflation rate is shifting with recent changes to the network. Before the Merge, inflation was 4.6%. Now stakers are rewarded differently, and new network usage will push annual inflation below 0.5%. If network activity picks up, it could turn negative.
As the digital asset space grows, it remains a small and volatile fragment of the overall economy. Moreover, with an estimated total market cap of about $1 trillion, changes in the supply of cryptocurrencies may have a minor impact than macro changes, such as a shift in monetary inflation, policy decisions, and large movements in the consumer price index.
Some people still associate crypto price cycles with Bitcoin halving cycles, recent institutionalization of the crypto market has made policy correlations increasingly important. The implication is that more significant economic trends outside cryptocurrency likely have more influence over prices than anything directly related to crypto.
Crypto and consumer price index (CPI)
The consumer price index (CPI) is the average change in the prices of a fixed basket of household goods and services. CPI is an essential metric for determining inflation levels in an economy, as it tracks the changes in the cost of living from one year to the next.
It is also important to note that when analyzing inflation’s effect on crypto, we must consider the global economy. Global inflation is an all-too-familiar situation in today’s economy, and it can be difficult for people to manage their finances when prices suddenly surge.
When that happens, necessities such as food and energy bills precede activities like investing in cryptocurrencies. In this scenario, people tend to save up as much disposable income and assets as possible, so it is no surprise that digital assets are the first on the chopping block when faced with rising costs. When faced with price increases, Bitcoin and other digital currencies tend to be prioritized lower than essential survival items.
Crypto and monetary inflation
Monetary inflation is an increase in the total amount of money circulating in an economy. Central banks cause it by issuing a new currency or commercial banks giving credit.
As central banks issue more and more of the world’s fiat currencies each passing year, the value of individual currency units decreases, and CPI rises.
A change in the current rate of monetary inflation can drastically affect the value of crypto, often resulting in significant gains when the money supply grows but struggles when it shrinks. Understanding its rate can help predict changes in crypto values, which can be helpful information for investors looking for a lucrative investment return.
Inflationary cryptocurrencies
In addition to Bitcoin and Ethereum Classic, many other cryptocurrencies have built-in inflation rates designed to reward holders. By increasing the number of tokens in circulation, these projects aim to reward users for holding their coins, which often leads to a rise in demand for the cryptocurrency.
These inflationary models also dictate how much each user will receive as a reward when they stake their coins.
Examples:
- Dogecoin has an unlimited supply meaning that the value of each coin could decrease over time if the supply increases faster than the demand.
- Bitcoin is inflationary but also has disinflationary measures which further slow down the inflation rate, called “halving.” The halving occurs every four years and reduces the number of coins awarded to miners.
Deflationary cryptocurrencies
These digital tokens have a limited supply, meaning users can only obtain them by buying from current holders or mining rewards. This scarcity can cause the value of these currencies to increase over time as demand exceeds supply.
Examples:
- Chainlink (LINK) has a fixed and known total supply of 1 billion LINK tokens.
- Binance coin (BNB) has burning mechanisms to bring the supply down to 100 million tokens.
- Ethereum (ETH) turned deflationary after the Merge.
Impact of inflation on crypto markets
The impact of inflation on crypto markets happens in two ways: firstly, it affects the prices of cryptocurrencies and how investors perceive and respond to real-world events. When inflation increases, investors tend to move their funds away from the traditional financial markets, such as stocks and bonds, into alternative investments like cryptocurrencies. They prefer crypto because they perceive cryptos as more stable than conventional assets in times of economic uncertainty or inflationary pressures.
Inflation can also lead to increased volatility in the crypto markets, as investors react when prices become volatile. In addition, it can be exacerbated by market speculation or manipulation, quickly sending prices in both directions.
9 tips for investing in tough economic times
Here are nine (9) investing tips that come in handy in tough economic times:
1. Diversify Your Portfolio: Don’t put all your eggs in one basket—spread your investments across different types of crypto and traditional assets to protect yourself from market volatility.
2. Research Before Investing: Research the cryptocurrency you’re investing in, and make sure it aligns with your investment goals.
3. Understand Risk Tolerance: Be aware of how much risk you are willing to take when investing in cryptocurrencies, and don’t invest more than you can afford to lose.
4. Utilize Stop Loss Orders: Establish stop loss orders that automatically close trades once prices reach a certain point to limit losses if the market takes an unexpected turn.
5. Consider Long-Term Investments: Don’t expect to get rich quickly—investments in cryptocurrencies can be volatile, so it’s essential to have a long-term outlook when considering them as part of your portfolio.
6. Use Technical Analysis: Understand and utilize basic technical analysis concepts when making investment decisions to help you identify market trends.
7. Stay Up-to-Date on Crypto News: Pay attention to the latest news and developments in cryptocurrency to help you make informed investment decisions.
8. Don’t Chase the Market: Don’t try to time the market by trying to buy or sell just as prices reach their peak—this can be extremely risky and often leads to losses.
9. Rebalancing Your Portfolio Regularly: Rebalancing your portfolio helps ensure that your investments align with your risk tolerance and long-term goals.
Conclusion
Cryptocurrencies have become an increasingly popular asset for investors worldwide, and their prices are driven mainly by inflation. As such, it’s essential to understand how inflation affects crypto markets and to take proactive steps when investing in them. By diversifying your portfolio, staying up-to-date on the news, using stop-loss orders, and understanding risk tolerance, you can help ensure that your investments remain profitable even during tough economic times.
