Inflation, shrinking cash and the rise of cryptocurrency

Those familiar with the cryptosphere will be well aware of the frequent conversations, if not raging debates, that happen concerning inflation, cash and cryptocurrency. Typically, these are in support of Bitcoin, with many arguing that - as a store of value - the flagship cryptocurrency is a strong hedge against a US dollar decreasing in value due to rampant and increasing money printing at the US Federal Reserve.

To fully understand this argument, it is first important to understand what inflation is and how it affects cash. Representing the (typically) constantly rising cost of goods and services, inflation is the means by which money becomes less valuable over time. A gallon of milk, for example, cost $2.52 in the US in 1995, however by 2020 it was $3.54 – meaning that the value of $2.52 fell over that 25-year period and by 2020, one could no longer buy the same item.

As such, inflation is an issue for cash as a long-term store of value, which is a problem as average people have tended to save in cash. In order to offset this, banks have historically offered interest rates on cash that have matched or exceeded the rate of inflation. In the UK, for example, the average rate of interest set by the Bank of England between 1975 and 2008 was 9.8%. At the same time, the average rate of inflation in the UK was 6.36%. In the US over the same period, inflation ran at an average of 3.5% per year while the average Federal Reserve Funds Rate was 6.4%.

This means that, over this ­33-year period, those saving in cash in the UK and US were, on average, able to protect the value of their cash from inflation, and even grow it. This was broadly the same in Europe and many other parts of the world. Since 2008, however, this situation has reversed. This is because, during the global financial crisis of 2008/09, central banks in developed economies – particularly in the US and UK – implemented wide-scale Quantitative Easing in order to keep stock markets afloat, a measure that has been ramped up significantly to tackle the economic fallout from the global Covid-19 pandemic.


Money printing and the death of interest rates  

Commonly referred to as money printing, Quantitative Easing (QE) involves central banks creating vast amounts of fresh currency within an economic system, typically by buying-up financial assets in main markets. In the US, the Federal Reserve has “printed” more than $6 trillion since September 2008, while the UK’s Bank of England has issued around £800 billion and the European Central Bank €5 trillion over the same period.

The economic theory behind QE is that the fresh money flowing into stock markets should encourage companies to invest and grow, which in turn should trickle down into the “real economy” and create jobs and wealth for average people. This is further encouraged by very low interest rates, which central banks hope will encourage companies to borrow in order to invest in their operations, boosting bank balance sheets in the process. Once things are more stable, the assets bought by central banks can be sold, thereby clearing the balance sheet.

The realities of QE, however, can be quite different. Moreover, the above does not take into account the negative effects of money printing. While it actually shrinks inflation, QE and the ultra-low interest rates that accompany it still reduces the value of cash at a faster rate than normal by giving no way to offset inflation. Between September 2008 and December 2020, for example, the average interest rate was just 1.6% in the UK and 0.7% in the US, while the average rate of inflation has been 2.7% and 1.8%, respectively.

This means that, for more than a decade, anyone saving in cash in the US, UK and many other developed economies has lost money in real terms as inflation has eaten into the value of their money. At the same time, wage growth has also been suppressed: in the UK, wage growth has been stagnant over this period, with workers earning 2.4% less today than in 2007 in real terms.

The birth of Bitcoin and a new monetary system

All of this has combined to create a pretty grim situation for average citizens of most developed economies. It is also one that was foreseen, at least in part, by Satoshi Nakamoto – the anonymous creator of Bitcoin. In 2009 Nakamoto launched the world’s first-ever blockchain, embedding in the first block a link to a Times of London article covering the news that the UK’s Chancellor of the Exchequer had approved a second multi-billion-pound bailout for banks – the architects of the global financial crisis.

As further elaborated in the Bitcoin whitepaper, Nakamoto aimed to create an egalitarian monetary system that could resist the corruption and criminality frequently enacted at multinational banks, and which had brought the world to its knees. This lofty aim gave birth to blockchain technology: an immutable, incorruptible ledger of transactions in a native digital currency that is owned, managed and controlled by users, which in this case was Bitcoin.

Since 2009, Bitcoin has risen in value from $0 to over $55,000 per coin today – annual growth of more than 264%. This, of course, has far outstripped the rate of inflation over the same period, as well as the rate of growth in almost any other global asset. Indeed, in a little over a decade Bitcoin has evolved from a pet project of computer programmers to an asset now held by some of the world’s biggest banks, fund managers and companies – including those that labeled it a scam as recently as 2018.

The past decade has also seen the evolution of an entire ecosystem of cryptocurrency, thanks in large part to the creation of Ethereum, a fully programmable blockchain. Ethereum is now host to the world of decentralized finance, or DeFi, consisting of hundreds of platforms and protocols that are finally realizing the aims of Bitcoin by opening up finance to the average person – without the involvement, or manipulation, of banks and governments.

Equal, cashless wealth creation without banks

Today, Ether – the native token of Ethereum – as well as thousands of other coins and tokens are also now beating inflation, providing wealth creation opportunities not available to average people in traditional finance. This includes the ability to earn up to 20% APY on stablecoins – tokens that are pegged to “real world” fiat currencies like the US dollar that do not suffer the famous volatility of Bitcoin and its peers. This type of opportunity has not been seen in traditional finance since the early 1990s.  

Indeed, with central bank balance sheets now at unprecedented levels and interest rates practically negative, it is unlikely cash will be a profitable way to save anytime soon. More than this, with no credible plan to perhaps ever shrink the $7 trillion outstanding at the Federal Reserve, it is possible that the world's reserve currency – the US dollar – starts to lose its value altogether. This is certainly the argument of Bitcoin “maximalists” who posit it as a store of value to rival USD, and even gold, hence its moniker “digital gold.”

Not everyone is convinced by the above argument: there remain plenty of actors in traditional finance vehemently against Bitcoin and other cryptocurrencies that prophesize a terrible disaster for those holding it. Despite this, the market continues to grow, with the total market cap of all digital assets now topping $1.7 trillion as cash has become obsolete as a store of value. Ultimately, it is up to individuals to decide how to save for their futures, but as the world moves in a digital direction in almost every other area, it is perhaps unsurprising that millions are choosing to do so in cryptocurrency.

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