Inflation is the process through which a currency gradually loses its value over a given period. It is often experienced in fiat currencies such as the U.S. dollar, Euro, or any other government-issued currency. It is driven by factors such as increased money supply, changes in demand and supply forces, and changes in economic conditions.
For instance, as the government prints more fiat money, each unit of the currency becomes less valuable. Inflation typically decreases the purchasing power of the currency, leading to an increase in the prices of assets. This means that the same amount of money purchases fewer goods or services than it did in the past.
Why are Cryptocurrencies Resistant to Inflation?
Investors treat cryptocurrencies like Bitcoin as a hedge against monetary inflation (sustained growth in currency supply) due to their decentralized nature. This means that no entity can manipulate cryptocurrencies by adjusting interest rates or increasing their supply to meet its policy objectives.
In addition, the scarcity of Bitcoin makes it appeal to investors as a deflationary asset. Bitcoin supply, for instance, is hard capped at 21 million coins only. This scarcity is programmed into the cryptocurrency’s code so that the maximum number of Bitcoin that can ever exist is fixed. It makes Bitcoin a deflationary asset rather than subject to monetary inflation.
Bitcoin also uses a unique process, called halving, to reduce the rate of releasing new coins to circulation. The process reduces the reward given to miners by half every four years. It ensures a gradual and steady coin issuance until it reaches the maximum supply. The scheduled reduction gives Bitcoin a predictable appeal to investors.
Generally, cryptocurrencies are designed to have low and predictable inflation rates. For instance, Bitcoin’s inflation rate by year is currently 1.8%, while Ethereum’s is approximately 0.5%.