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Cryptocurrency adoption has significantly grown in the modern-day world, with more people joining the digital currency usage brigade. These digital assets have revolutionized the financial system by turning it digital and influencing aspects such as access, efficiency, and financial depth. Over the past few years, cryptos have experienced exponential growth. The market space of cryptos has grown to approximately $ 2 billion in 2022 as compared to the $828 billion valuations they held in 2018. Due to some developments and traits associated with cryptos, digital currencies have become prone to inflation. The increase in global inflation saw the cryptos’ market value swing between $3 trillion and $1.5 trillion in the span of a few months.
The Relationship Between Crypto and Inflation
Initially, cryptos were meant to be immune to inflation to protect their users’ buying power. However, the relationship between cryptos and inflation has shifted significantly in recent times. Much like any other legal tender, cryptocurrencies have an evolving relationship with the global economy. As a result, changes in the situation of the worldwide economy result in changes in the connection made.
Inflation
Inflation is the process through which a given currency, be it a cryptocurrency or traditional tender like bitcoin, decreases in value over time. This process results in the prices of goods going up in most cases. According to experts, while seemingly negative, the process is beneficial in helping the economy in question grow over time. The process is responsible for promoting economic growth despite facilitating a loss in purchasing power that any given currency holds. This growth is achieved by creating a currency that the future economy needs. The development of cryptocurrencies came about as a payment method to act as an alternative to legal tenders such as the dollar. These cryptocurrencies were believed to be the remedy to the ideology that legal tenders such as the dollar will depreciate in value over time. For a time, virtual currencies proved to be the solution to this problem. Following their inception into the modern financial markets, cryptos gained value faster than the inflation rate over the same period. Cryptos such as bitcoin and Ethereum sporadically grew in value after being introduced into the market. This growth is reflected in the cryptos transitioning from valueless whitepapers to a booming economy. This booming economy has approximately $ 250 billion committed to various DeFi applications. These applications include crowdfunding, lending, decentralized exchanges, and liquidity pools. However, trends have shifted over the past few years to influence the cryptos' immunity to inflation negatively. Cryptocurrencies have dipped by approximately 25% due to inflation alone in the last twelve months. The drop is associated with some factors, as explained below.
The Reasons Behind The Crypto Inflation
Ties to Traditional Finance
As the uptake of cryptos and digital finance becomes more mainstream, the relationship between cryptos and traditional finance institutions becomes stronger. The recent trends showcase an influx of institutional investors using cryptos such as bitcoin as hedges for funds. The influx of corporations investing in the cryptos has also tied them to traditional financial markets such as the stock market. As a result, these cryptos have become susceptible to the same issues and influences that plague traditional markets. As a result, issues such as the conflict between Russia and Ukraine have affected the prices and selling of digital assets.
Government Regulations And Bans on Cryptos
Recent government actions have resulted in the drop experienced across the global crypto economy. The influx of regulations introduced by governments has also slowed the growth of cryptos. These regulations have introduced new ideas associated with digital assets such as cryptocurrencies and NFTs. Due to economic juggernauts such as China and India introducing strict regulations and banning volatile cryptos, the global market has been significantly affected. The two countries alone held 35% of the worldwide crypto market share.
Loss of Hype and Structural Volatility
Cryptocurrency growth is majorly associated with what businessmen call ‘hype’ or FOMO ( Fear of Missing Out). Virtual currencies such as bitcoin are considered to be “speculative assets.” According to some analysts, as long as the assets tread on a speculation road, they are prone to dips and nosedives as the ‘talk’ lessens. Similarly, practices such as mining have resulted in some form of devaluation of the cryptos. However, this feature is temporary as the supply of cryptos is finite.
Author’s Take
The growth of cryptos has catapulted the adoption of a digital economy worldwide. This growth has reached a critical point as cryptos become mainstream. While this growth is positive, the relationship between cryptos and inflation has also been affected. Changes such as integrating traditional finance, introducing government regulation, and hype have made cryptos prone to inflation. These changes have made the cryptos lose their immunity to inflation. As a result, some experts have criticized digital assets as an alternative currency to the dollar or gold. However, there remains much to be seen about cryptocurrencies as the assets are still in the early development stage.