Crypto and Inflation

Inflation is by definition an increase in the supply of currency. Banks are therefore the main source of inflation as they are allowed to engage in fractional reserve banking, a practice in which currency is issued out of thin air.

The current system of fractional reserve banking, backed by central banks as lenders of last resort, is highly inflationary. This is evident when comparing the purchasing power of the dollar today with what it was back a hundred years ago when the current financial regime was first installed. The dollar has lost about 97 percent of its purchasing power since then.

Now, with the advent of crypto as an alternative to central bank currency, some believe that the era of inflation is over, and that we will once again see sound money return to our economy. However, there is nothing particularly sound about crypto currencies.

The main thing to keep in mind about currency is that it is a claim on a resource. This is its very purpose. What makes prices rise when a currency is inflated is the fact that more currency is making claims to resources that do not necessarily rise in abundance as quickly as the currency.

Crypto-currencies are therefore inflationary by their very nature. There is no resource tied up to a token of crypto. Rather, resources are spent producing them. It takes a lot of energy to compute a crypto-token. Yet, all that is returned to the economy is a number.

However, as long as the numbers produced are deemed more valuable than the resources spent, no price inflation results. But there is nevertheless inflation. The currency supply increases.

At the moment, crypto-tokens are deemed extremely valuable. They catch tremendous prices. People are willing to spend a lot of central bank issued fiat to get hold of these tokens.

The eagerness to convert fiat into crypto soaks up fiat. The emergence of crypto has therefore added to price stability of other goods. With crypto soaking up excess fiat, other goods and services are less affected by central bank inflation.

So, while crypto is inflationary, it is currently acting as a price stabilizer for the overall economy. However, that will reverse once people want to spend their crypto on tangible assets. With no resource tied to the crypto-tokens, prices can only go up once they start circulating in the wider economy.