Modern monetary theory would lead us to believe that government stimulus and inflation do not always have a negative impact on an economy. Indeed, a small degree of inflation is necessary to keep the fiat economy stimulated and growing.
If the value of the currency you
are using and its purchasing power decreases every year, then you have an incentive to spend the currency today rather than keep it for tomorrow.
Spending your currency stimulates the economy and leads to more lending and growth from the business sector, which increases the number of products and services, as well as higher-paying jobs for workers.
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When it gets ugly
Most central banks aim to keep inflation between 2-3% to have a healthy economy that incentivizes spending over saving. Markets do best when there is predictability and stability.
When inflation becomes too high and citizens cannot afford to buy goods and services, the economy will spiral down and begin to contract. High inflation reduces spending, taxes collected, employment levels and government services offered.
The case for high inflation is positive for the adoption of cryptocurrencies
There are two main areas where high inflation can be a good sign for cryptocurrency adoption. The first can be seen in extreme circumstances where countries encounter hyperinflation. Hyperinflation is typically measured when inflation rises by more than 50% per month. Famous examples where countries experience hyperinflation are in the German Weimar Republic of 1920, Peru in 1990 and Zimbabwe in 2008/2009. For citizens living in a country experiencing hyperinflation, crypto can offer a lifeline. When high levels of inflation start, citizens can transfer their savings into stablecoins that retain their value while their native currency depreciates.
The second example of when high inflation can be a good sign for cryptocurrency adoption is when inflation exceeds the central bank’s acceptable 2-3% levels. Most countries are now in this scenario, which is evident from the inflation data of Canada and the United States.
These examples show a clear devaluation of traditionally strong fiat currencies and a loss of their purchasing power. Every U.S. dollar earned and unspent last year has lost 8.5% of its purchasing power today.
Stablecoins offer great protection against failing currencies that experience hyperinflation. They work by anchoring their value to more stable fiat currencies. However, what happens when these more stable fiat currencies experience higher inflation levels.
This is when citizens can look to other cryptocurrencies that hold their value better against the rising inflation of their fiat alternatives. Bitcoin is a good example of this and is often used as an inflation hedge by users.
The case against high inflation that is good for cryptocurrencies
While the adoption of cryptocurrencies is growing worldwide, it is estimated that the average rate of ownership is still only 3.9%. While inflation is a great incentive for people to start looking at cryptocurrencies as an alternative or hedge. The reality is that there simply isn’t the knowledge base or infrastructure to support this at scale. Projects like the Lightning Network are helping to bridge the gap between consumers and accessibility for crypto payments. However, before this becomes standard practice for people, there will need to be a full-scale education about what cryptography is and how money basically works.
The main reason why high inflation is not a good sign for cryptocurrency adoption is simply that people do not believe they can afford to invest. During times of high inflation, unless people receive annual increases that meet or exceed inflation levels, they simply have less disposable income to allocate them. Very few places will accept cryptocurrencies as payment for rent, mortgage, groceries, or gas.
In addition, the adoption of Bitcoin and other cryptocurrencies by institutional investors is growing, but in times of high inflation, these same institutions will try to liquidate their riskier assets. These include cryptocurrencies and technology stocks. While Bitcoin has demonstrated continued growth and long-term stability, it remains a volatile option for short-term investors. Together with high inflation, it simply poses too much risk for institutional investors to have on their balance sheets.
Conclusion: Inflation will persist
Regardless of what your opinion is on pandemic spending, the result would always end in higher levels of inflation.
Governments cannot introduce high volumes of new currency into circulation and not expect it to have an impact on the value of the current supply.
These inflation data are worrying and show no signs of slowing down. Whether this leads to a cryptographic standard or simply greater adoption is up for debate.
