Inflation, the monetary crisis and the growth of cryptocurrencies

To properly understand this argument in favor of Bitcoin being an excellent hedging tool, it is first important to understand what inflation is and how it affects money.

Inflation, which is (usually) an ever-increasing cost of goods and services, is the means by which money loses its value over time. For example, a gallon of milk in the USA in 1995 cost $2.52, and in 2021 – $4.4. This means that over a 25-year period, its value has increased, and in 2021 you will no longer be able to buy the same product at the old price.

Thus, inflation creates difficulties for cash as a long-term store of value, which is a problem because ordinary citizens tend to make savings in cash. To compensate for this, banks have historically offered cash interest rates that matched or exceeded the inflation rate.

In the UK, for example, the average interest rate set by the Bank of England between 1975 and 2008 was 9.8%. At the same time, the average inflation rate in the UK was 6.36%. In the US, over the same period, inflation averaged 3.5% per year, and the average Federal Reserve funds rate was 6.4%.

This means that over this 33-year period, cash depositors in the UK and the US, on average, were able to protect the value of their money from inflation, and even increase it. The same was generally the case in Europe and many other parts of the world. However, since 2008, this situation has changed to the opposite. This is due to the fact that during the global financial crisis of 2008/09, central banks of developed countries, in particular the United States and Great Britain, carried out large-scale quantitative easing (QE) to keep stock markets afloat, and this step was significantly strengthened to overcome the economic consequences of the global Covid-19 pandemic.

Money Printing and the Death to interest rates

Known as money printing, quantitative easing (QE) involves central banks creating a large amount of fresh currency in the economic system, usually by buying financial assets in major markets. In the United States, the Federal Reserve System has “printed” more than $9 trillion since September 2008, the Bank of England has issued about 1,600 billion pounds over the same period, and the European Central Bank has issued 9 trillion euros.

The economic theory behind QE is that the influx of fresh money into stock markets should encourage companies to invest and grow, which, in turn, should spread to the “real economy” and create jobs and wealth for people in general. This is facilitated by very low interest rates, which central banks hope will encourage companies to take out loans to invest in their activities, while strengthening banks’ balance sheets. When the situation becomes more stable, assets bought by central banks can be sold, which will clear the balance sheet.

However, the reality of QE may be completely different. Moreover, all of the above does not take into account the negative consequences of money printing. While it is true that this reduces inflation in the short term, QE and its accompanying very low interest rates still reduce the value of cash faster than usual, without offering any way to offset inflation. For example, between September 2008 and December 2020, the average interest rate was only 1.6% in the UK and 0.7% in the US, while the average inflation rate was 2.7% and 1.8%, respectively.

This means that for more than a decade, everyone who keeps cash in the US, UK and many other advanced economies has been losing money in real terms as inflation has eaten into the value of money. At the same time, wage growth is also restrained: in the UK, wage growth has stalled over this period, and today workers earn 3.4% less than in 2007 in real terms.

The Birth of Bitcoin and the New Monetary System

All this combined has created a rather gloomy situation for the average citizen in most countries with developed economies. This is also a situation that Satoshi Nakamoto, the anonymous creator of Bitcoin, at least partially foresaw. In 2009, Nakamoto launched the world’s first blockchain, embedding in the first block a link to an article in the London Times, in which it was reported that the Chancellor of the Treasury of Great Britain approved the second multibillion-dollar rescue of the banks – architects of the global financial crisis.

As explained in the Bitcoin white paper, Nakamoto sought to create a fair monetary system capable of countering the corruption and crime that often afflict multinational banks, and brought the world to its knees. This lofty goal has led to the emergence of blockchain technology: an immutable and incorruptible register of transactions in its own digital currency, which is owned, managed and controlled by users, and in this case, it is the BTC.

Since 2009, the value of Bitcoin has grown from 0 to more than $42,000 per coin today. That is, according to Coinmarketrate.com, the annual growth of the crypto asset was more than 264%. This, of course, is much faster than the inflation rate over the same period, as well as the growth rate of almost any other asset in the world. Indeed, in a little more than a decade, Bitcoin has gone from a programmer’s home project to an asset that is now owned by some of the world’s largest banks, fund management companies and corporations, including those who called it a fraud in 2018.

Over the past decade, an entire cryptocurrency ecosystem has also been formed, largely due to the creation of Ethereum, a fully programmable blockchain. Ethereum has become home to the world of decentralized finance, or DeFi, consisting of hundreds of platforms and protocols that finally realize the goals of Bitcoin, opening finance to ordinary citizens, without the participation or manipulation of banks and governments.

Fair, cashless and non-bank wealth creation

Today, Ether (ETH), the native token of Ethereum, as well as thousands of other coins and tokens, are also defeating inflation, providing opportunities for wealth creation that are not available to ordinary people in traditional finance. This includes the opportunity to earn up to 20% APR in stable coins – tokens tied to fiat currencies of the “real world”, such as the US dollar, which do not suffer from the famous volatility of Bitcoin and the like. There have been no such opportunities in traditional financing since the early 1990s.

Indeed, given that central banks’ balance sheets are now at unprecedented levels and interest rates are practically negative, cash is unlikely to be a cost-effective way of saving in the short term. Moreover, without a convincing plan for possible debt reduction of the Federal Reserve System, it is possible that the world’s reserve currency, the US dollar, will begin to completely lose its value. This is, of course, the argument of the “maximalists” who consider the BTC a benchmark of value competing with the dollar and even gold, hence its nickname “digital gold”.

Not everyone is convinced by the above arguments: there are still many players in traditional finance who oppose Bitcoin and other cryptocurrencies and predict a terrible catastrophe for those who hold them. Despite this, the market continues to grow, and the total market capitalization of all digital assets now exceeds $1.9 trillion, as cash has lost its value as a store of value.

Ultimately, it’s people who decide how to save for their future, but since the world is moving in a digital direction in almost all other areas, perhaps it’s not surprising that millions of people prefer to do it in cryptocurrencies.