Do Cryptocurrencies Act As a Hedge Against High Inflation?

In recent years, cryptocurrencies have emerged as a popular alternative for individuals in countries suffering from high inflation. These digital assets offer a potential hedge against the devaluation of fiat currencies, providing a store of value that can preserve wealth amidst economic turmoil. In high inflation environments, where national currencies lose value rapidly, cryptocurrencies such as Bitcoin and Ethereum present a more stable alternative.

They are particularly attractive in countries like Venezuela, Argentina, and Zimbabwe, where inflation rates have soared, rendering local currencies nearly worthless. By leveraging the limited supply and decentralized nature of cryptocurrencies, people in these regions can protect their savings, conduct transactions, and even facilitate remittances, bypassing the inefficiencies and restrictions of traditional financial systems.

Ozgur #Guneri, the CEO of #Turkish #crypto exchange #BtcTurk, has stepped down after seven years but will remain as a board director. BtcTurk founder Kerem #Tibuk will take over as CEO as the company plans to expand globally.

Amid high inflation in Turkey, cryptocurrencies have… pic.twitter.com/NDQEXvhT0v

— TOBTC (@_TOBTC) July 19, 2024

Central Banks Demand More Regulations of Cryptocurrencies

Cryptocurrencies have amplified financial risks in emerging markets rather than mitigating them, according to central banks. The Bank for International Settlements (BIS) stressed that while cryptocurrencies were promoted as low-cost payment solutions, their appeal remains “illusory”. The BIS suggests that these assets should be regulated similarly to other financial assets due to their risk potential​​.

The Consultative Group of Directors of Financial Stability, which includes central banks from the US, Argentina, Brazil, Canada, Chile, and Mexico, said that cryptocurrencies have increased financial risks in less developed economies. They noted that weaker legal systems in these regions complicate contract enforcement, leading to greater market risks​.

Further, the International Monetary Fund (IMF) has warned about the destabilizing impact of cryptocurrency on capital flows in emerging markets, where high inflation and volatile exchange rates make national currencies vulnerable​​.

In a broader context, the European Central Bank (ECB) and other regulators continue to express concerns over the potential future risks posed by the deepening integration of cryptocurrencies with traditional financial systems​.

Cryptocurrencies Thrive in High Inflation Countries

As we pointed out in our intro, people in high inflation countries turn to cryptocurrencies for several reasons. For instance, Venezuela, with its 400% inflation rate, sees many residents using cryptocurrencies to preserve their savings from hyperinflation. The same goes for countries like Argentina and Zimbabwe, where inflation rates are 98.6% and 172.2% respectively, national currencies lose value rapidly. In countries with strict capital controls, such as Iran (39.2% inflation) and Turkey (50.6% inflation), cryptocurrencies offer a way to move money across borders without government restrictions.

Stablecoins (notably $USDT on Tron) are the product market of crypto, serving as hedge against local currency volatility and devaluation

Stablecoin purchases are 4% of Turkey’s GDP, as the Lira had an annual inflation rate as high at 67% in March

And yet most people in the west… https://t.co/UFDJ0UKOlM pic.twitter.com/a7h3Xsjr8T

— Zach Rynes | CLG (@ChainLinkGod) June 21, 2024

There are 6 key reasons why cryptocurrencies thrive in countries with a high inflation:

1. Hedge Against Inflation: Cryptocurrencies, particularly Bitcoin, are seen as a hedge against inflation. Unlike national currencies, which can lose value rapidly in high inflation environments, cryptocurrencies are often viewed as a store of value due to their limited supply. For example, Bitcoin has a capped supply of 21 million coins, which theoretically makes it immune to inflationary pressures that devalue fiat currencies.
2. Currency Stability: In countries experiencing hyperinflation or significant currency depreciation, cryptocurrencies can offer more stability. Traditional fiat currencies in these regions can lose value extremely quickly, while cryptocurrencies may retain or even increase their value over time, providing a safer alternative for savings.
3. Accessibility and Ease of Use: Cryptocurrencies can be more accessible than traditional banking systems, especially in regions with underdeveloped financial infrastructure. They allow people to store and transfer value digitally without the need for banks, which can be unstable or unreliable in high inflation environments.
4. Economic Uncertainty and Capital Controls: In many high inflation countries, governments impose capital controls to prevent money from leaving the country. Cryptocurrencies can circumvent these controls, allowing individuals to move their money across borders and preserve their wealth. This is particularly relevant in countries like Venezuela and Argentina, where strict capital controls are in place.
5. Remittances: Cryptocurrencies offer a cost-effective and quick method for sending remittances. In high inflation countries, the cost and speed of traditional remittance services can be prohibitive, making cryptocurrencies an attractive alternative.
6. Financial Inclusion: Cryptocurrencies provide financial services to the unbanked and underbanked populations. In countries where access to banking services is limited, cryptocurrencies can enable people to participate in the global economy.

Here’s a more complete list of countries currently experiencing high inflation rates, and the top 10 consists of the following countries:

• Venezuela: 400%
• Zimbabwe: 172.2%
• Argentina: 98.6%
• Sudan: 71.6%
• Turkey: 50.6%
• Ghana: 45.4%
• Haiti: 44.5%
• Suriname: 42.7%
• Iran: 39.2%
• Sierra Leone: 37.8%​

But Is Everything Really so Bad?

While cryptocurrency volatility is indeed an issue, in some high inflation countries, it may be perceived as less problematic compared to the extreme devaluation of national currencies. Here’s a detailed comparison:

1. Comparative Stability

• Cryptocurrencies: Despite their notorious price fluctuations, major cryptocurrencies like Bitcoin and Ethereum have periods of relative stability. The fixed supply of many cryptocurrencies, such as Bitcoin’s cap at 21 million coins, can offer a more predictable monetary policy compared to fiat currencies in high inflation environments​.
• High Inflation Currencies: In countries like Venezuela (283% inflation) and Argentina (161% inflation), national currencies can devalue rapidly, eroding purchasing power on a daily basis. This extreme and persistent inflation can make cryptocurrencies appear comparatively stable and appealing.

2. Store of Value

• Cryptocurrencies: Over the long term, some cryptocurrencies have shown an upward trend in value, despite short-term volatility. For people in high inflation countries, cryptocurrencies can serve as a store of value that is more reliable than their national currency, which continuously loses value​.
• High Inflation Currencies: Persistent inflation drastically reduces the value of savings held in local currencies. People might prefer the risks of cryptocurrency volatility over the guaranteed loss of value in their national currency.

3. Accessibility and Usage

• Cryptocurrencies: They provide a decentralized and accessible means of transacting and saving, which can be particularly valuable in countries with unstable banking systems. Cryptocurrencies can be accessed through smartphones and the internet, which are becoming increasingly available worldwide​.
• High Inflation Currencies: Banking systems in high inflation countries often face challenges like liquidity issues and mistrust from the public. Cryptocurrencies can bypass these traditional systems, offering a more reliable alternative.

4. Inflation Hedging

• Cryptocurrencies: Some cryptocurrencies are specifically designed to hedge against inflation. For instance, Bitcoin is often referred to as “digital gold” because of its limited supply and its use as a store of value.
• High Inflation Currencies: High inflation can lead to hyperinflation, where the local currency becomes virtually worthless. In such scenarios, even the volatile nature of cryptocurrencies can seem like a safer bet​.

Case Study: Venezuela

Venezuela has been experiencing one of the most severe economic crises in modern history. The country’s inflation rate reached a staggering 400% in recent years, leading to hyperinflation and a catastrophic devaluation of the national currency, the bolívar​. In response to the economic instability, many Venezuelans have turned to cryptocurrencies, particularly Bitcoin, as a hedge against hyperinflation. Cryptocurrencies offer a level of stability and reliability that the bolívar cannot provide.

The local currency, the bolívar, has lost nearly all its value, prompting people to use cryptocurrencies for everyday transactions and savings​.

The Venezuelan government has had a mixed response to the rise of cryptocurrencies. It launched its own cryptocurrency, the Petro, which is purportedly backed by the country’s oil reserves. However, the Petro has not gained significant traction among the populace or in the international community.

Pragmatic Response to Extreme Economic Instability

The adoption of cryptocurrencies in countries like Venezuela illustrates a pragmatic response to extreme economic instability. While not without its risks, the use of cryptocurrencies has provided Venezuelans with an alternative means to preserve wealth, conduct transactions, and receive remittances amid hyperinflation. The case study shows both the potential and the challenges of using digital currencies in a high-inflation environment.

And whereas governments demand more regulation, reality shows that a public in need of a monetary stability will turn to crypto, no matter what.