Exploring the Relationship Between Cryptocurrency and Inflation
Understanding the relationship between crypto and inflation requires analyzing factors such as interest rates, quantitative easing and tightening, and money supply.
- Cryptocurrency’s limited history and decentralized nature have made it difficult to determine the impact of inflation on its value, unlike traditional fiat currencies.
- Crypto prices exhibit an inverse relationship with interest rates.
Cryptocurrency, being a little over 10 years old, has not yet fully experienced the implications of inflation. Traditional fiat currencies, which are currencies backed by the issuing government rather than a commodity (e.g., gold), on the other hand, have a long history of inflationary cycles. As a result, we can easily determine the relationship between fiat currencies and inflation, but not between cryptocurrencies and inflation. And considering the decentralized nature of cryptocurrencies and their limited supply, the impact of inflation on the value of cryptocurrencies remains uncharted territory.
Interest Rates
According to S&P Global’s report, Are crypto markets correlated with macroeconomic factors?, crypto prices have an inverse relationship with interest rates. The authors of the report analyzed whether the inverse relationship between interest rates and crypto prices is supported by the data. They note that low-interest rates increase the appetite for assets with higher risk and higher returns, which could include crypto assets.
Conversely, when the Federal Reserve (Fed) and other major central banks increase benchmark interest rates, higher-yielding assets become less attractive, which could also apply to crypto assets.
Quantitative Easing and Tightening
Quantitative easing (QE) and quantitative tightening (QT) can affect cryptocurrency markets. QE increases liquidity and money supply and increases interest in higher-risk assets. This was seen during the 2020 bull run when Bitcoin prices rose significantly alongside a QE program.
However, periods of QT and tightening monetary policy, like the one in 2022, can lead to bearish periods for cryptocurrencies. The relationship between bond yields and crypto prices is also important, as negative term premia during the 2020-2021 rally drove investors toward cryptocurrencies.
Money Supply
Money supply is important for the crypto ecosystem. The measure of money supply increased significantly since the Great Recession due to central banks implementing policies like QE. According to the report, there is a positive correlation of 0.75 between the money supply and the crypto index since 2017. However, this relationship broke down in 2018 when the crypto market experienced a decline despite continued growth in the money supply. In the second half of 2022, both the money supply and the crypto market faced negative returns due to various events, including the collapse of stablecoin UST and the downfall of the cryptocurrency exchange FTX.
Final Thoughts
The relationship between cryptocurrency and inflation is complex and still subject to analysis. Crypto assets, such as Bitcoin, have characteristics that could potentially make them a hedge against inflation, like their decentralized nature. cryptocurrencies can be subject to their own volatility and speculative behavior, which can make them susceptible to price fluctuations unrelated to traditional inflationary factors.
Inside Telecom provides you with an extensive list of content covering all aspects of the Tech industry. Keep an eye on our Cryptocurrency section to stay informed and updated with our daily articles.