Authored by Demelza Hays via The Mises Institute,
Two years ago, Bitcoin was considered a fringe technology for libertarians and computer geeks. Now, Bitcoin and other cryptocurrencies, such as Ethereum, are gaining mainstream adoption. However, mainstream adoption has been propelled by financial speculation instead of by demand for a privately minted and deflationary medium of exchange. After the Fed’s rate hike this week, Bitcoin and alternative cryptocurrencies, such as Ethereum and Dash dropped in value instantly. Bitcoin, for example, dropped by approximately 16% in value while other coins dropped by approximately 25%. However, Bitcoin’s price recovered to the previous high within 18 hours.
The reaction of the cryptomarket to the Federal Reserve announcement provides evidence that cryptocurrencies are seen as a safe-haven investment during times of significant fiat currency dilution. As I wrote for Forbes Austria in April, this is why the demand for Bitcoin is going up in countries that are demonetizing their fiat currencies, such as India and Venezuela. Following the demonetization of the 500 and 1,000 rupee banknotes in November of last year, the price of Bitcoin on India’s largest Bitcoin exchange, Unocoin, shot up to $818 while American exchanges quoted the exchange rate as $709 per Bitcoin. Similarly, Surbitcoin, Venezuela’s largest Bitcoin exchange, saw an increase from 450 accounts in 2014 to over 85,000 in 2016.
Reacting to Fed Policy
However, if the Fed continues to raise rates, then the demand for cryptocurrency may decrease. When the Fed closes the faucet on newly printed money, there is less newly printed money that can flow into asset classes such as real estate, stocks, and cryptocurrencies, etc. Therefore, investors will have less demand for assets that hedge against inflation.
Bitcoin Inflation
Contrary to popular belief that Bitcoin is deflationary, the currency currently has an annual inflation rate of approximately 4%. The reason that Bitcoin allows investors to hedge the expansionary monetary policies adhered to by central banks is because the demand for Bitcoin is growing at a pace that is higher than the increase in the supply of Bitcoin. As explained in a Mises Daily article written by Frank Shostak in 2002, the term inflation was originally used to describe an increase in the money supply. Today, the term inflation refers to a general increase in prices.
If the original definition is applied, then Bitcoin is an inflationary currency. However, as I discussed in the 2017 edition of In Gold We Trust, the supply of newly minted Bitcoin follows a predictable inflation rate that diminishes over time. Satoshi modeled the flow of new Bitcoin as a Poisson process, which will result in a discernible inflation rate compared to the stock of existing Bitcoin by 2020. Every four years, the amount of Bitcoin minted annually is halved. The last programmed “halving” occurred in June of 2016. Therefore, the next halving will occur in 2020. The inverse of the inflation rate, the StFR, also indicates the decreasing flow of newly minted coins into the Bitcoin economy. The stock to flow ratio (StFR) of Bitcoin is currently 25 years; however, the StFR ratio will increase to approximately 56 years. This means that the StFR of Bitcoin should surpass gold’s during the next five years. Prior to January 3, 2009, no Bitcoin existed. Therefore, Bitcoin’s StFR was effectively zero. However, the rapid reduction in the amount of Bitcoin mining over time results in an increasing StFR over time. By 2024, only 3.125 Bitcoin will be mined every ten minutes resulting in a StFR of approximately 119 years.
If the new meaning of inflation is applied, then Bitcoin is deflationary because the purchasing power of each unit increases overtime.
When I began investing in Bitcoin in 2014, a Model S Tesla worth $70,000 cost 230 Bitcoin. Today, a Model S Tesla worth $70,000 costs 28 Bitcoin. On June 11 of this year, the price of Bitcoin reached a new all-time high above $3,000 after trading at approximately $2,300 two weeks ago. Furthermore, Bitcoin’s market capitalization of $40 billion is expected to rise further as the uncertainty surrounding this technology decreases. Bitcoin’s price data only covers the past six years, which means there is basically no data available for statistical analysis.
Risk Assessments
The Ellsberg paradox shows that people prefer outcomes with known probability distributions compared to outcomes where the probabilities are unknown. The estimation error associated with forecasts of Bitcoin’s risks and returns may be negatively biasing the price downward. As time passes, people will become more “experienced” with Bitcoin, which may reduce uncertainty and the subsequent discount it wields on the price of Bitcoin.
An economic downturn occurs approximately once every ten years in the US, and it has been a decade since the 2007/2008 financial meltdown. If the economy cannot handle the increase in rates, and the Fed is forced to reverse their decision, the price of Bitcoin and other cryptocurrencies are likely to respond positively. Although the cryptocurrency market took a steep plunge after Janet Yellen’s second rate hike of 2017, prices fully recovered within a day. The quick rebound underscores the lack of assets that allow investors to accumulate wealth safely. Negative interest rates in Europe and fiat demonetization in developing countries are still driving demand for Bitcoin and alternative cryptocurrencies. Although Bitcoin was initially ridiculed as money for computer nerds and a conduit for illegal activity, investors are beginning to see the potential for this technology to be an integral part of wealth management from the perspective of portfolio diversification.
Source : ZeroHedge
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There is going to be an absolute tsunami of fiat wealth flowing into crypto over the next few years. Trillions, literally. We will see $100k BTC and $1000 BTS. Crypto has not even started to absorb fiat wealth yet. Boooom
Yes, I completely agree. A better “money” is upon us. One that can't be abused by a few people.
sure a select few are abusing the system but the population is also doing it to themselves by relying on credit for everything, they give them the power.
That's true. What a combination of contributing factors, right?
Scary times we live in! only time will tell. Credit free for all and excessive money printing can't go on forever.
Cryptocurrencies are the perfect store of wealth and hedge against inflation. They are not cumbersome like the precious metals, nor is there an element of danger at the point of exchange. I am a fan of the precious metals, but cryptocurrencies will be taking their place in the currency arena in the not too distant future. I believe that the powers that be want to try to string on the suppression in the metals market until this move into cryptocurrencies relieves the pressure that they are under due to their naked short positions in the metals. I still like silver, a lot, for industrial reasons.
i think both metals and cryptos will have their place.
This is true.
The fact that Bitcoin and Ethereum are being discussed and debated by financial authorities around the world is evidence that it's recognized as a medium of exchange -- despite the slow official acceptance of that fact. And because blockchain currencies are NOT subject to political manipulation (yet?) they are also serving as both a store of value and a vehicle of investment. The inherent deflationary nature discussed here is part of what encourages people to consider it a store of value. Hurray!
I believe you made some great points in this article. I do agree that as it becomes difficult to expand the money supply for cyrptocurrencies they become more attractive vehicles for holding wealth and for diversification.
With regards to rate increases affecting the price of cryptocurrencies, I think when the Federal Reserve or other central banks raise interest rates it's having similar effect of cryptocurrencies as it would on any conventional currencies. As economists love to say is that people love to respond to incentives. Rate increases by the US Federal reserve as well as other central banks tend to make their currencies more attractive as short term and possibly long term interest rates rise for assets such bonds denominated in those currencies.
While the % gains in adoption are great, there's still a hell of a lot of people still not involved in Cryptocurrency. Which to me can only mean one thing moving forward... Bbbbbooom time ahead!
Yes, cryptocurrency adoption has a lot of room to grow! I'm the only one using cryptocurrency where I'm staying, even though I've tried getting people on board... They will come around soon. :)
What I like most about cryptocurrencies is that they cannot be abused because they are decentralized. Let's face it: too much power in the hands of a few will always be abused. With time, more and more people will realize the freedom that comes with cryptocurrency and adopt it.
I'm pro cryptocurrency until I die.
interesting post, BTC is the leading Cryptocc. maybe because some big dogs already put there stake into it some financial prophets predict 1BTC goes up to 10.000 dollars and more. Time will tell !
Thanks for this post Zer0Hedge
Very detailed and thorough post, I agree the central banks are making many people explore other means of investment. Once crypto really hits mainstream adoption this boom will probably seem small in comparison. I sent you a follow if you wish to do the same it would be appreciated. Thanks and keep up the awesome work!
if u see now the price of bitcoin has fallen down from peak point which has occured a few days back
Excellent article - it's just a matter of time before crypto currencies take over the current fiat currency platform.
I didn't realise there was such a strong reaction in the crypto markets to the rate hike. Such a strong correlation between the behaviour of crypto markets and government announcements is a sure sign that cryptos are considered credible by a growing number of people/institutions. Thanks for the post
great post I feel crypto currency will crash the fiat economy and this is the point of fear in the government and the reserves leading to all the ups and dwns and fear tactics in crypto space glad to see these days as we move fwd into the future of crypto space
Simply New era is a cryptocurrency era in money world
thanks for the post. really good :)
Thanks for such a wonderful analysis!
Asia control the markets... cryptos, gold and silver will slow down central banks but regulation and laws will still control and enslave is 😐😩
hey zer0hedge.. loved ur post again check out mine https://steemit.com/cryptocurrency/@danlupi/bitcoin-bubble-or-are-we-in-the-next-evolution