The Banking Executive Magazine - July 2022 Issue

Inflation and Crypto Since inflation has been a constant threat to the value stored in fiat, peo- ple often protect themselves by in- vesting in assets that maintain their value over time. Historically, gold has been used as a hedge against in- flation, but now crypto has become a more popular alternative over re- cent years. Use of cryptocurrency during inflation include: Hedging against inflation Bitcoin is fundamentally a deflation- ary asset, which is why citizens of countries with unstable fiat curren- cies are increasingly using it as a store of value to protect against hy- perinflation and rising costs of every- day goods and services. Unlike fiat, crypto cannot be manipulated to the same extent by changing interest rates and increased money printing. Most importantly, Bitcoin’s supply will never exceed 21 million which makes it an attractive store of value that is resistant to inflation. While Bitcoin has surged in popularity over the past year, the crypto market’s volatile nature continues to be a po- larizing topic. Stablecoin Alternative Cryptocurrencies often experience sudden price movements, which for many, makes them an unattractive store of value. Investors hesitant about crypto’s volatile nature, can consider using secured, fiat-backed stablecoins. THE LINK BETWEEN BITCOIN AND INFLATION Coindesk analysis by Robert Stevens, revealed that some investors have flocked to bitcoin in order to protect their wealth from the impact of ram- pant inflation. CoinDesk is Bitcoin, Ethereum, Crypto news and price data. It is leader in cryptocurrency, Bitcoin, Ethereum, XRP, blockchain, Decen- tralized Finance DeFi, digital finance and Web 3.0 news. Cryptocurrency is often considered an inflation-resistant asset, and is often seen as an asset class that is un- correlated with real-world assets. However, cryptocurrencies are unique, and some are inflationary by design. Crypto advocates think that allowing central bankers to influence the economy through monetary policies, namely quantitative easing, leads to disaster. Crypto advocates often say that cryp- tocurrencies like bitcoin (BTC) are re- sistant to the incompetence of central bankers and governments because they are decentralized, and cannot be shut down. Another reason is that bitcoin’s issuance is determined by code. While more bitcoins enters circula- tion over time, the rate at which new bitcoin is issued to miners is deter- mined by the Bitcoin protocol. The supply is capped, and supplies of new coins are estimated around the year. Unlike central banks, whose economists must respond to market events, the Bitcoin blockchain runs like clockwork. Approximately every four years, the protocol cuts the issuance of new bit- coin by half, known as the “halving”. Bitcoin’s fixed supply has led some fans to consider it akin to “digital gold" which is inflation-resistant asset. Stores of value assets stand the test of time because they are uncor- related with other assets and are re- sistant to entities that interfere with the market. In the past few years, bitcoin has tracked the United States stock mar- ket, which performs well when the economy is stimulated and stutters when spending decreases. However, not all cryptocurrencies work like bitcoin. Some cryptocur- rencies are deflationary meaning that the supply decreases over time, de- signed to increase the value of the coin over time if the demand re- mained the same. Other cryptocurrencies have dy- namic supplies and some tokens, like non-fungible tokens (NFTs), are one of a kind. TIME-SCALE ANALYSIS OF RELATION BETWEEN INFLATION AND CRYPTO Academic research by Thomas Con- lona (et al), published in Elsevier Economics Letters, attempted to identify the time-series relation be- tween cryptocurrency prices and for- ward inflation expectations. Using wavelet time-scale techniques, a positive link between cryptocurren- cies and forward inflation rates is identified, focused on a brief period surrounding the onset of the COVID- 19 pandemic. This coincides with a rapid and synchronized decrease in cryptocurrency prices and forward inflation expectations, followed by a swift recovery to pre-crisis levels. Outside of the crisis period, there was no clear evidence of any infla- tion hedging capacity of Bitcoin or Ethereum during times of increasing forward inflation expectations. During previous occasions of high inflation, investors attempted to pre- serve their purchasing power by in- vesting in assets such as gold, property and stocks. The recent ad- dition of cryptocurrencies as an in- vestment option has added a possible new alternative inflation hedge. Empirical findings suggest that cryptocurrencies do not hedge against increases in forward inflation expectations, but instead may derive price-related information from fac- tors common to forward inflation ex- pectations during times of crisis. These findings add to the mounting questions over the role of cryptocur- rencies as a financial asset. While a transitory link between cryptocurren- cies and forward inflation expecta- tions is evident, the absence of consistent hedging properties may be a cause for alarm as investors attempt to find storage of value outside of tra- ditional mechanisms. Such despera- tion to maintain wealth within ISSUE 163 JULY 2022 the BANKING EXECUTIVE 11