The word inflation is something you are probably hearing quite a bit in the past few months. With the war in Ukraine, plus the pandemic going on, the inflation rate is something everyone seems to be talking about in the news. While the exact meaning isn’t always clear, the effects are undeniable.
With those reports, you also hear of rising gas and food prices and even shortages in some cases. Overall, this means a generally lower standard of living, and these things directly result from inflation and can cause lasting changes.
For many people, the meaning of inflation is a bit vague. The most basic definition of inflation is the loss of value in a currency. When this happens, the purchasing power of your money decreases while prices increase.
For example, with 20 dollars, you might be able to buy an entire meal from a fast-food restaurant. However, that 20 dollars loses its value over time with inflation, and it might only be enough to get you a sandwich from that same restaurant in the near future. Inflation happens all the time, and though it sounds frightening, it’s not as bad as it seems.
It is so common that the inflation rate is part of most countries’ economic models. While they can’t stop it, governments try to limit it. They manage this because the government and central banks are backed by fiat currencies instead of gold. This backing allows them to maintain control over it and take steps to prevent inflation from getting too high.
If inflation is too high, it can hurt the national economy by decreasing economic growth. If consumer spending in the general public is down, there is less money in circulation.
The Benefits of Inflation in the Economic Model
Inflation isn’t always bad. Assets such as land, gold, and cryptocurrencies can increase their value. Since cash is no longer a reliable resource, demand for other assets increases. Bitcoin and other cryptocurrencies are beneficiaries of inflation. Inflation affects currencies like the dollar, and demand goes down, Cryptocurrency is the alternative.
Additionally, since inflation affects their currency, some countries build their economy around that. Keeping inflation rates relatively high can attract foreign investors. Even with high inflation, investments pouring in can counter the effects. An example of this is Japan which has the third-largest economy globally yet with a relatively weak currency. Their secret is a nearly unlimited supply of money from the constant investment. Since the Yen is so cheap, consumer prices in Japan are some of the lowest in the world.
The Risk and Downside of Inflation
While China and Japan prove that the inflationary model can be an advantage, they at least make sure it is stable. These countries have firm control over their economies, and to keep their fiat currency under control, they conduct their research. On the other hand, countries like Zimbabwe and Venezuela cannot control inflation, leading to hyperinflation.
Hyperinflation is when the currency spirals out of control and becomes worthless. It can get so bad that they rely on the US dollar to pay for things. However, the difference is that there is no investment coming in here.
There are several reasons why that is the case. When a government can’t control inflation, interest rates tend to be higher. Governments do this to compensate for the lack of purchasing power. However, that also defeats the advantage investors look for in places like this: low start-up costs.
Second, high inflation rates are also a common cause of political and social unrest. It isn’t uncommon to find protests, widespread criminal activity, and terrorist groups in countries with hyperinflation. These make investors less inclined to invest in these countries due to security concerns.
Inflation in Digital Currency
However, in our section above, we only talked about fiat currencies like the US dollar. This begs the question, how does it affect Bitcoin and other cryptocurrencies?
The short answer is yes. Cryptos are subject to the law of supply and demand. When more digital money is being mined, they are inflationary tokens, which means more money is coming in than taken out. When too much supply is present, those assets’ value will decline, which causes inflating prices.
Inflating price happens all the time with crypto due to its volatility. An infamous example was in June 2021, when Elon Musk made a tweet which saw the price of Bitcoin plummet to 40% of its all-time highest value the previous month.
Inflationary Tokens and Its Effect on Token Holders
We should first define what an inflationary token is before discussing its effects. You consider a token inflationary when its net amount is constantly increasing, which means that the number of tokens is continually growing. Bitcoin works under this model, with its number cap at around 21 million coins.
We have not reached that cap, so the number is still increasing. That means supply is still growing, and there is plenty of token distribution.
However, like with inflation, the product’s actual value can go down as supply increases. If the supply gets too big, it can cause prices to go down. That is why a program known as halving is present in the Bitcoin protocol.
This method halves the discovery rate for new Bitcoin every four years. This protocol slows down the currencies supply and prevents it from going out of control. Being able to control supply means Bitcoin becomes more predictable for investors making smart contracts.
The Rise of Token Supply
Too much supply affects cryptos and the dollar. When there is too much supply, the total value of that item goes down. If you keep printing, you destroy it.
The value of crypto, and any good, depends on how rare it is. Why should people expect to pay for something when they can find it lying around wherever they go. Something like Bitcoin takes an effort, so having it far too easy for people to see can be a problem. People will be less willing to pay for these tokens if they are easy to get.
People are less inclined to spend their Bitcoin since they may have to sell it for far less than they bought it originally. It can get so bad that the value might not even cover transaction fees in some cases.
If anything, inflation and too much supply can turn people off and have them looking for alternatives for their finances. This relationship defines standard currencies like the dollar and
Inflation in Fiat Currencies vis-à-vis Inflation in Digital Currency
The relationship between traditional money and digital assets is interesting. The inflation of our traditional currency is what got people to begin taking Bitcoin seriously. Back in the early days of Bitcoin, it was almost worthless as a currency.
However, that all changed with the Global Financial Crisis. Since prices are increasing, people are now less willing to spend their money. Usually, people rely on their bank accounts to save their money for a rainy day.
However, the wealth you have in your savings account loses its value with inflation, and that means your pool of resources only continues to decrease. When this happens, people turn to place their wealth in assets that maintain their value. That is a need that cryptos can answer.
Unlike your bank account, Bitcoin and other cryptocurrencies were unaffected by inflating prices. In many ways, crypto has become the perfect place to store your money for the time being.
Cryptocurrencies do not depend on the government to prop them up. Instead, they are like land and property. Instead, the value of Bitcoin comes from the blockchain network it uses.
Supply didn’t grow out of control because Bitcoin mining happens steadily. What does increase is the demand for it. More and more people are now using Bitcoin wallets and other cryptocurrencies to store their assets.
Even as the economy improved, people saw the benefits of digital tokens and made them part of their investment portfolio. It’s now the alternative to the banks that people can turn to when banking isn’t profitable.
In many ways, cryptocurrencies are no different from any other commodities. It is susceptible to the laws of supply and demand. There will always be ups and downs with the prices. Cryptocurrencies are a proven means of storing your resources and a worthwhile investment despite these issues.
When traditional means cannot help you, places like Bitcoin can become an alternative. Having it ready helped keep many people afloat during the difficult years of the recession.
However, not everything is perfect with these new cryptocurrencies though, and there is a reason some people are still reluctant to invest in them. It can still be susceptible to inflate prices even with stopgaps in place. In the short term, you can continue to expect those issues to persist.
Another is that, at the moment, digital money is still somewhat volatile, and you can expect the costs to continue going up and down.