Effect of Inflation on Crypto Investments and Alternatives to Invest in

In the developed world, inflation is at an all-time high — the US peaking at an annual rate of 8.5% in March 2022 — as the world deals with COVID-19 disruptions, a surge in consumer demand and the war in Ukraine (among other geopolitical conflicts).  Even the crypto market, always thought to be inflation resistant, isn’t as untouchable as enthusiasts say, as evidenced by the stablecoin Terra (UST) crash in May.

Financial advisors believe that inflation will always happen despite the government’s efforts to tighten monetary policy to tame it. So, how do you minimize the effects of inflation on your investment portfolio? We look at the impact of inflation on crypto investments and highlight some effective alternative assets that can help your portfolio outpace inflation in the long run.

Plunge in cryptocurrency prices

The crypto market cap is at less than $1 trillion, which is its lowest since it peaked at $3 trillion in 2021. While inflation is skyrocketing the price of commodities, crypto prices are nosediving fast. For instance, Bitcoin recently hit $17k in June, while Ethereum went under $1k for the first time since early 2021.

This price crash has seen crypto investors, especially young traders who saw crypto as a get-rich-quick scheme, lose big. Most of these traders have been left with huge debts leading to feelings of fear and mental health anguish. Even worse, financial experts claim this crypto winter might last longer as traders pull liquidity out of the crypto markets.

Unsurprisingly, traders who have lost big are battling depression, with some contemplating suicide — there has been a spike in suicidal social media posts. Therapists for cryptocurrency-related mental health issues believe the market crash will also increase the severity of crypto addiction symptoms. Hopefully, crypto exchange platforms will put more emphasis on introducing programs similar to problem gambling help centers found in online casinos to help traders survive the upcoming recession.

Why BTC isn’t an inflation hedge

Crypto enthusiasts have long considered BTC the digital gold — a limited resource meant to be a solid inflation hedge. For starters, there will only be a supply of 21 million BTC coins, solidifying the limited resource claim. What’s more, the most recent crypto bull run saw the price of BTC reach a high of $67k while inflation rates remained low, providing a compelling reason it could be a good inflation hedge.

However, the recent tumble in Bitcoin value as the rate of inflation hit new heights seems to have crumbled this theory. As soon as inflation reared its ugly head after the Fed offered unprecedented stimulus packages due to the COVID-19 pandemic, Bitcoin fell apart. Well, not completely apart like Terra, but it lost almost 80% of its value, proving it’s not immune to inflation.

This has had dire consequences, especially for countries such as El Salvador, which adopted BTC as legal tender. Some economists believe this adoption by financial systems could be why Bitcoin isn’t a good hedge. What’s more, big institutions buying Bitcoin, as well as the availability of Bitcoin futures and ETFs, has increased the correlation between crypto and other traditional financial assets.

That said, there is still hope that Bitcoin could become the digital gold investors have hoped for as crypto adoption worldwide increases. The increased adoption might help give BTC more real word utility and reduce its volatility. This could see its fluctuation correlate inversely with inflation rates.

Effective Assets to Diversify Your Portfolio

While the jury is still out on the viability of Bitcoin as a hedge against inflation due to its volatility, it’s advisable to diversify your portfolio to include well-known illiquid assets. Unlike liquid assets, which are more prone to inflation, illiquid assets have a natural defense against inflation — they generate interest as inflation rises. Therefore, you need to have more illiquid assets in your portfolio to withstand inflation and the bear market.

Here are a few illiquid assets to consider:

Commodities

Commodities are raw materials such as natural gas and precious metals that can be traded on the futures market. Commodity investments go back to the early days of trading silk and spices. Today, you can get into commodity markets by buying these raw materials directly or purchasing shares in commodity companies or exchange-traded funds (ETFs).

When the U.S dollar value declines during high inflation, demand for commodities increases. As a result, commodity prices rise. This price increase means investors holding stocks in commodity companies reap huge returns. Therefore, commodities hedge against a decline in fiat currency.

That said, it’s worth noting that commodities are also quite volatile since futures involve speculation. Therefore, consider your time horizon and risk profile before buying a commodity. Better yet, you can invest in commodities through an exchange-traded fund or mutual funds to help deal with the volatility.

Commodity exposure in the current inflation market will protect you against losing your purchase power in the long term and will diversify your investment portfolio.

Treasury Inflation-protected Securities (TIPS)

Like commodities, inflation-protected securities protect your investment returns in the long run. Treasury Inflation-Protected Securities (TIPS) are fixed income securities offered by the government that earn you interest payments. While they work like treasury bonds, the government adjusts their par value based on the consumer price index, protecting the investor against inflation — ordinary bonds have fixed par values.

What’s more, TIPS interest payments are calculated based on the TIPS’ current par value. As a result, they increase with CPI inflation — you never get fewer returns than your original TIPS value.

TIPS can be bought directly from the treasury or through an online broker. There is also the option of buying ETFs and mutual funds that have diverse mixes of TIPS.

Bottom Line

The current global inflation has led to a decline in most asset prices, including Bitcoin — despite being considered an inflation hedge. The current market rout has seen most people lose their investments and savings, leaving most young investors on the cusp of depression.

However, it’s not all doom and gloom in this bear market. With experts predicting a possible crypto winter, you can diversify your investment portfolio with assets such as commodities and TIPS to stave off high inflation.