How cryptocurrencies can be leveraged to beat inflation

Decentralised stablecoins can deliver a regular and consistent yield that matches or even beats the rate of inflation

The crypto market, which includes currencies such as Bitcoin, pictured, has lost $2 trillion of its value in six months. Unsplash

The price of Ethereum, the second largest cryptocurrency by market size, has fallen by 70 per cent this year. Investors and analysts are watching to see if it will dip below $1,000. Unsplash

Dogecoin, supported by Elon Musk, is about 90 per cent down from May last year, yet it is outperforming Bitcoin and Ethereum in the current crash. Unsplash

The government of El Salvador has invested $105 million in Bitcoin. President Nayib Bukele's embrace of the cryptocurrency as legal tender is being questioned as the market crashes. Getty

Changpeng Zhao, founder of crypto exchange giant Binance, has compared the current market turmoil to the dotcom bubble of the early 2000s. Still, the company is aggressively pursuing licensing in international jurisdictions and introducing new products. Getty

Tether is the biggest issuer of stablecoins, a type of cryptocurrency pegged to a traditionally stable asset like the US dollar. Most stablecoins are meant to maintain a constant price of $1 and are backed by real reserve funds, making it easy to convert crypto investments into cash. But Tether's financial statements show that may not be true, leaving the issuer and its investors vulnerable. Unsplash

The recent crypto crash can in part be attributed to the collapse of TerraUSD, a stablecoin pegged to the US dollar through algorithms and linked to a "sister" cryptocurrency named Luna. When the price of Luna plummeted, TerraUSD also fell, creating a “death spiral” to practically zero for both coins. Unsplash

On June 12 crypto lender Celsius Network said it had paused customer withdrawals, saying it needed “to stabilise liquidity and operations”. Investors are still waiting, with no signs that the current meltdown will let up. Getty

For an economy to flourish, the inflation rate needs to sit at about 2 per cent, according to most economists.

If inflation is too low, we risk a sluggish economy and weak wage growth, while if it is too high, people’s savings and purchasing power shrink.

Right now, we are facing the latter scenario, with inflation sitting at an astonishing 8.6 per cent in the US — the highest rate recorded in four decades.

Globally, inflation is now creeping up the driveway of almost every person. The question on everyone’s mind is: how can one protect their purchasing power in the face of rapidly rising prices?

A true gauge of inflation

The first step is to understand what the rate of inflation truly is. The way that inflation is calculated has not changed for more than 100 years and so there are a number of gaps and inaccuracies.

As such, we need a radical rethink of how we collect and collate data. US inflation is running much closer to 11 per cent, according to the Truflation index, a blockchain-based inflation data aggregator.

This extra 2 per cent makes a huge difference in the lives of average Americans. With basic groceries now running into hundreds of dollars during each supermarket visit, people are already cutting back on services beyond their basic needs.

At some point, the average consumer will be forced to choose between energy and groceries, or transport and new shoes. At that point, the economy will begin to suffer.

How loose monetary policy affects inflation

The founders of cryptocurrencies have had their eyes on inflation for a long time.

The first “genesis” block of the Bitcoin blockchain contains code that refers to an article from The Times in 2009, which reported on how George Osborne, then chancellor of the exchequer, was planning to issue a second £1 billion ($1.19bn) bailout for banks during the financial crisis.

Satoshi Nakamoto, the anonymous creator of Bitcoin, understood that rampant money printing by central banks in 2008 and 2009 was going to create a dangerous inflationary environment.

That was before the Covid-19 pandemic, which has driven money printing to heights no one could possibly have imagined.

Since January 2020, the US Federal Reserve has added $5 trillion to its balance sheet as part of its monetary stimulus package. This adds to the $4tn accumulated in large part between 2008 and 2020. (A fully accurate figure is not available as the Fed stopped publishing its balance sheet on its website in 2020).

Questions are now being asked whether this enormous level of borrowing can ever be recouped and how much damage it could cause the economy and citizens.

The small rate increases in recent weeks that have led markets into bear territory could simply be the beginning of what the Fed would need to do if it plans to balance its books.

A call for industry collaboration

Cryptocurrencies are now in one of the sharpest downturns the industry has ever seen, thanks in large part due to increasing inflation and subsequent interest rate increases that have scared away investors accustomed to easy money.

The recent blow-up in TerraUSD also didn’t help, with the loss of $60 billion almost overnight, making “algorithmic stablecoins” a dirty word.

However, such innovations have a vital role to play in a cryptocurrency ecosystem that could beat inflation.

While fiat-backed stablecoins have proved a lifeline during recent bouts of volatility, a truly decentralised stablecoin that can deliver a regular and consistent yield in a safe and stable way — one that matches or perhaps even beats inflation — is the holy grail everyone in this industry should be chasing.

The more volatile cryptocurrencies will always appeal to risk-hungry investors, but for the rest of the world, we need something a little less risky.

We need something similar to what cash savings used to do and help the average person to preserve the value of their money.

If the cryptocurrency industry works together in this bear market, we can achieve this.

Stefan Rust is the founder of Laguna Labs, a blockchain development house, and former chief executive of bitcoin.com