Crypto will become an inflation hedge – but not yet

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Crypto will become an inflation hedge – but not yet

Cryptocurrencies present a unique solution, given their lack of a governing central bank. You can’t lose faith in something that doesn’t exist. Its 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 actual value of the annual percentage return is tied to the economic activity of the chain via its treasury and staking reward distribution mechanisms. These properties seem to tackle the cause of inflation in traditional monetary systems, but some obstacles remain.

Related: Inflation got you down? 5 ways to accumulate crypto with little to no fees

To get started, let’s look at the reasons why people invest and hold cryptocurrencies. The majority of cryptocurrency holders see the coming potential of these technologies, which means that part of their value is not currently present. These are speculative investments. Decentralization was achieved by Bitcoin, but its exuberant energy costs remain unaddressed, and the majority of mining forces are still clustered in a dozen mining pools. Ethereum has similar issues with power consumption and centralized mining pool. Ethereum also has a security problem – over $1.2 billion has already been Fly 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 trading volume, Uniswap, offers inefficient pricing compared to a centralized exchange. A simple exchange of $1 million in Tether (USDT) for USD Coin (USDC) would cost over $30,000 more in fees and slippage than when executed on a centralized exchange.

These are technological problems that have solutions

Certainly, these problems are being solved. Several third-generation blockchains tackle 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 hypertransparency. Projects seeking to merge the mathematical rigor of traditional finance with the native attributes of cryptocurrency are tackling the problem of DEX inefficiency.

Related: Ronin hackers transferred stolen funds from ETH to BTC and used sanctioned mixers

Massive adoption and integration must take place before crypto can act as a hedge against inflation. The crypto has characteristics of future value in an ecosystem that is currently struggling to establish its fundamentals. 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 value exchanged is regularly lost will remain unworkable.

Until major cryptocurrencies can be used effectively for real-world payments and decentralized applications offer a level of utility similar to that of centralized systems, crypto will continue to be treated as a growth stock.

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

Inflation is not caused simply by printing more money, i.e. the presence of an asset does not automatically reduce its value. Between September 2008 and November 2008, the number of billions of US dollars in circulation tripled, but inflation fell.

Inflation has much more to do with public distrust of the central monetary system. This lack of confidence—combined with rising business prices, disruptions caused by pandemic relief programs, and significant supply chain disruptions (accelerated, in part, by the war in Ukraine)—we plunged into the current crisis. The large monetary footprint of 2021 did not cause inflation, but it amplified it.

Related: Has US inflation peaked? 5 things to know

In terms of presence, the provision of funds alone is not too big an issue for a store of value currency. What is stored is not necessarily part of the circulating supply. Gold, for example, exists in large volumes in the form of jewelry, bullion, etc., but in much smaller volumes in the commodity market. A market that took into account all the gold mined on earth would have a totally different price. Because these jewels and ingots are not traded on the market at all, they do not affect the supply and demand curve. The same goes for currency.

Inflation is the result of a loss of confidence in the ability of an asset to store its value over a long period. Most goods in this world are finite, so every party aware of the increase in supply but uncertain of monetary policy will automatically price it in. Inflation becomes a self-fulfilling prophecy.

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

Cryptocurrencies fail as an inflation hedge during times of high volatility and market uncertainty. That said, they generally excel in stable growth environments where they easily outperform the market and where the relatively low market capitalization compared to fiat currencies works in their favor as a growth stock. Current solutions to the usability problem are not sustainable due to their speculative nature and low transaction rate

Jarek Hirniak is the founder and CEO of Generation Lambda and a certified quant with over 20 years of experience in software development. He spent six years working in trading systems at Citadel Securities and UBS, where he developed a series of new trading systems and trading-related software platforms while leading multidisciplinary teams.

The opinions expressed are those of the author alone and do not necessarily reflect the views of Cointelegraph. This article is for general informational purposes and is not intended to be and should not be considered legal or investment advice.

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