Crypto Is Becoming An Inflation Hedge – Just Not Yet

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Cryptocurrencies offer a unique solution, given the lack of a central governing bank. You can’t lose faith in something that doesn’t exist. The supply is finite, so it naturally increases in value. People using a blockchain with proof-of-stake protocols can access their funds at any time while continuously earning staking rewards on their current balance. This means that the true value of the annual percentage return is linked to the economic activity in the chain through the treasury and stock-reward distribution mechanisms. Those traits seem to address the root cause of inflation in traditional monetary systems, but some hurdles remain.

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For starters, let’s take a look at the reasons why people invest in cryptocurrencies and keep them. Majority of cryptocurrency holders see the future potential of those technologies, meaning some of their value is not currently Gift. They are speculative investments. Decentralization has been achieved by Bitcoin, but its exuberant energy costs remain untouched, and the majority of mining forces are still pooled in a dozen mining pools. Ethereum has similar problems with energy consumption and the centralization of mining pools. Ethereum also has a security problem – more than $1.2 billion has already been stolen on its blockchain this year.

There is also the problem of decentralized exchanges, or DEXs, which are currently not as suitable for use as centralized exchanges. The DEX with the highest transaction volume, Uniswap, offers inefficient pricing compared to a centralized exchange. A simple $1 million trade in Tether (USDT) for USD Coin (USDC) would cost over $30,000 more in fees and slippage than if executed on a centralized exchange.

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These are technological problems that have solutions

Granted, these issues are being addressed. Several third-generation blockchains are tackling energy consumption and decentralization head-on. Privacy improves. Crypto holders are beginning to accept that their wallets will always be fully traceable, which will appeal to new users who were previously hesitant about blockchain’s hyper-transparency. Projects seeking to merge the mathematical rigor of traditional finance with the native features of cryptocurrency are tackling the problem of DEX inefficiency.

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Mass adoption and integration must take place before crypto can act as a bulwark against inflation. Crypto has features of future value in an ecosystem that is currently struggling to establish its foundations. The crypto economy is still waiting for applications that will take full advantage of decentralization without sacrificing quality and experience, which is especially important for widespread adoption. A payment system where each transaction costs $5 and the exchanged value is regularly lost remains unfeasible.

Until the best cryptocurrencies can be used efficiently for real-world payments and decentralized applications offer a comparable level of usability to centralized systems, crypto continues to be treated as a growth stock.

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Inflation is caused by a lack of trust – something crypto still needs

Inflation is not caused by just printing more money, that is, the presence an asset does not automatically cause its value to fall. Between September 2008 and November 2008, the number of billions of dollars in circulation tripled, but inflation has fallen.

Inflation has much more to do with public distrust of the central monetary system. This lack of confidence – coupled with corporate price increases, the turmoil caused by pandemic aid packages and significant supply chain disruptions (partially accelerated by the war in Ukraine) – has brought us into the current crisis. The big money pressure of 2021 did not cause inflation, but magnified it.

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In terms of presence, the supply of funds alone is not too much of a problem for a store of value currency. What is stored is not necessarily part of the circulating inventory. For example, gold exists in large volumes in the form of jewelry, precious metals and so on, but in much smaller volumes in the commodity market. A market that took into account all the gold mined on Earth would have a completely different price. Since these jewelry and precious metals are not traded in the market at all, they do not affect the supply and demand curve. The same goes for currency.

Inflation results from a loss of confidence that an asset is able to store its value over a long period of time. Most commodities in this world are finite, so any party aware of the increased supply but unsure of monetary policy will automatically include it in their prices. Inflation becomes a self-fulfilling prophecy.

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Crypto as an inflation hedge is possible, but not in the current climate

Cryptocurrencies fail as an inflation hedge in times of high volatility and market uncertainty. That said, they generally excel in steady growth environments where they easily outperform the market and where the relatively small market cap compared to fiat currencies plays in their favor as a growth stock. Current solutions to the usability problem are unsustainable due to their speculative nature and low transaction costs

Jarek Hirniak is the founder and CEO of Generation Lambda and a certified quantum with over 20 years of experience in software development. He spent six years on trading systems at Citadel Securities and UBS, developing a range of new trading systems and trading-related software platforms while leading multidisciplinary teams.

The views expressed are those of the author only and do not necessarily reflect the views of ETN. This article is for general information purposes only and is not intended and should not be construed as legal or investment advice.

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