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Cryptocurrency as a defense against inflation. Why it doesn’t work?

The idea that cryptocurrencies are more resistant to inflation than fiat currencies has made them attractive to investors. Experts explained what the disadvantages of such a strategy are in reality.

Deficits make the medium of accumulation – gold or bitcoin – resistant to inflation. That’s why bitcoin is often called “digital gold.” Its total number will not exceed 21 million coins, which gives it an advantage over fiat currencies, the issue of which is unlimited.

Other cryptocurrencies, such as Ethereum, have another mechanism to protect against inflation: burning. But this is not a new idea. In traditional economics, there is such a thing as stock buybacks. While buybacks and coin flaring are not exactly the same thing, the concepts are very similar.

The cryptocurrency community has expanded significantly in recent years, and many of its members have pinned their hopes on cryptocurrencies as a means to keep their savings safe.

Experts told how realistic it is to save from inflation with the help of digital non-state currencies today.

Cryptocurrency as a tool to protect against inflation is used by many participants in the crypto market, in particular institutional players, said Victor Pershikov, lead analyst at 8848 Invest.

“Given the daily issuance relative to cryptocurrencies already in circulation, the internal inflation of BTC and ETH is small (1.75% and 0.5% as of today), and not comparable to the inflation in fiat currencies, which now reaches double-digit values. That is why cryptocurrency is the optimal tool for those market players who are looking for a tool to preserve value in the long term,” Pershikov said.

Despite this, it is impossible to call bitcoin and other crypto-assets optimal tools against inflation, the expert stressed. He noted that there are difficulties in using cryptocurrencies that reduce the demand for them as deflationary assets, namely:

  • High volatility of cryptocurrencies;
  • Lack of regulation;
  • Lack of reliable custodians.

“These and several other aspects limit the amount of funds that institutions are willing to place in cryptocurrency in order to protect them from inflation in fiat currencies. In other words, the risks of cryptocurrencies are too high to talk about an unambiguous application of digital assets as a tool against inflation,” the specialist explained.

According to him, from the point of view of developing economies, cryptocurrency may be a tool to help preserve value. However, a significant drop in cryptocurrency rates against USD (as well as against RUB) reduces the advantage of BTC and ETH as low-inflationary assets: as a result, a person will still go “to cash” rather than stay in crypto, and even if inflation does not eat up his money, he will lose some assets against the background of falling capitalization of the crypto market, Pershikov warned.

“Thus, technologically, cryptocurrencies are really a tool against inflation, but in reality there are a lot of “buts” of such application,” Victor Pershikov concluded.

Nikita Zuborev, a senior analyst at BestChange.ru, added that it is actually quite difficult to protect against inflation with the help of cryptocurrency. The main property of a protective asset should be a relatively low volatility, which no cryptocurrency project can boast of, except for stabelcoins – hybrid assets.

“If we look at cryptocurrencies solely as long-term investments, on average they can protect against inflation and even generate returns significantly higher than traditional conservative stock market instruments. Still, that doesn’t make them a protective asset. After all, for investments shorter than two years, there are more time horizons, which would bring losses, than profitable scenarios,” the expert explained.

He connected it with the fact that any rapid growth of the crypto market capitalization is followed by a prolonged deep correction. For example, from November 2021 to today, bitcoin has lost about half in price – about 56%, and the market on average even more.

“Here are the staplecoins with their subsequent investment in various credit-investment DeFi-protocols, directly or indirectly, as a safeguard against inflation. For example, centralized crypto-exchanges as an intermediary allow earning about 10% per annum in currency, which is very good by the standards of the traditional market,” – said the analyst.

He added that if we consider investments directly in DeFi, under certain conditions, it is possible to achieve 50% or even more than 100% per annum, with different risks of investment strategies. But the main option here is to provide liquidity on decentralized exchanges.

According to Zuborev, it’s worth bearing in mind that an asset used for inflation protection should have good liquidity, i.e. ease of conversion into the national currency and back.

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