Crypto will become an inflation hedge – just not yet

Cryptocurrencies present a unique solution, given their lack of a central governing bank. You can’t lose faith in something that doesn’t exist. The supply is limited, so it naturally increases in value. People using a blockchain with proof-of-stake protocols can access their money at any time, while continuously earning stake rewards on their current balance. This means that the actual value of the annual percentage return is tied to the economic activity in the chain via its treasury and stake reward distribution mechanics. These features appear to address the cause of inflation in the traditional monetary systems – but some roadblocks remain.

Related: Inflation Got You Down? 5 ways to accumulate crypto with little or no cost

First, let’s examine the reasons why people invest in and hold cryptocurrencies. The majority of cryptocurrency holders see future the potential of these technologies, meaning that some of their value is not currently present. They are speculative investments. Decentralization has been achieved by Bitcoin, but its exorbitantly high energy costs remain unaddressed, and the majority of mining forces are still concentrated in a dozen mining pools. Ethereum has similar issues with energy consumption and mining pool centralization. Ethereum also has a security problem – more than $1.2 billion has already been stolen on the blockchain this year.

There is also the issue of decentralized exchanges, or DEXs, which are currently not as suitable for use as centralized exchanges. The DEX with the highest transaction volume, Uniswap, offers inefficient pricing compared to a centralized exchange. A simple trade of $1 million in Tether (USDT) for USD Coin (USDC) will cost over $30,000 more in fees and slippage than when done on a centralized exchange.

These are technology problems that have solutions

Admittedly, these issues are being addressed. Several third-generation blockchains tackle energy consumption and decentralization head on. Privacy is getting better. Crypto holders are beginning to accept that their wallets will always be fully traceable, which will prove tempting to new users who have previously been hesitant about blockchain’s hyper-transparency. Projects that seek to merge the mathematical rigor of traditional finance with the native characteristics of cryptocurrency tackle the problem of DEX inefficiency.

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

Mass adoption and integration must happen before crypto can act as a bulwark against inflation. 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 the quality and experience, which is especially important for widespread use. A payment system where each transaction costs $5 and the exchanged value is regularly lost will remain unworkable.

Until the best cryptocurrencies can be effectively used for real-world payments and decentralized applications provide a similar level of utility to 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 by simply printing more money, that is presence of an asset does not automatically lead to a decrease in value. Between September 2008 and November 2008, the number of billions of US dollars in circulation tripled, but inflation decreased.

Inflation has much more to do with public distrust of the central monetary system. This lack of confidence—combined with corporate price falls, the upheaval caused by pandemic aid packages and significant supply chain disruptions (in part precipitated by the war in Ukraine)—has led us into the current crisis. The big money squeeze in 2021 didn’t cause inflation, but it magnified it.

Related: Has US Inflation Peaked? 5 things to know

In terms of presence, supply of funds alone is not too significant a problem for a currency with a store of value. What is stored is not necessarily part of the circulating supply. Gold is found, for example, in large volumes in the form of jewellery, bullion and so on, but in much smaller volumes on the commodity market. A market that took into account all the mined gold on earth would have a completely different price. Because these jewelry and bullion are not traded in the market at all, they do not affect the supply and demand curve. The same applies to currency.

Wow Year on year inflation in Europe in July. pic.twitter.com/VGWQ1OQOcB

— Arnaud Bertrand (@RnaudBertrand) 27 August 2022

Inflation is the result of a loss of confidence that an asset is capable of storing its value over a long period of time. Most goods in this world are finite, so all parties aware of the increased supply but uncertain about monetary policy will automatically factor it into their prices. Inflation becomes a self-fulfilling prophecy.

Crypto as an inflation hedge is possible, but not in today’s climate

Cryptocurrencies fail as an inflation hedge in times of high volatility and market uncertainty. That said, they generally excel in steady growth environments where they easily outperform the market and where the relatively small 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 volume

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