What is the impact of cryptocurrencies on the economy?
Cryptocurrency is much more than just an economic innovation: it is a form of social, cultural and technological progress. Due to their accessible nature, cryptocurrencies have the potential to boost the economy immensely.
Cryptocurrencies are digital assets held by cryptographic algorithms. There are different types of cryptocurrencies. Bitcoin (BTC) is probably the best known cryptocurrency, but thousands of others have been added over time. Of course, this also includes stablecoins, cryptocurrencies whose value is linked, for example, to fiat currency, debt securities or commodities such as gold.
As cryptocurrency prices correct and the fear and greed index rebounds, it’s important to take a deep breath and understand that the broader impact of cryptocurrencies goes beyond daily price swings. The use cases of cryptocurrencies and the blockchain technologies behind them are evolving at an exponential rate. The enormous economic impact of cryptocurrencies on the global economy cuts across industries beyond national borders, surpassing what was impossible not too long ago.
Cryptocurrencies have their pros and cons, like any tool or technology. The positive effects of cryptocurrencies are profound. One of the biggest advantages is undoubtedly its accessibility. Cryptocurrencies can be used to pay or receive payments without the involvement of third parties such as banks. The status quo of the current financial system has probably disappointed many people around the world. In fact, more than 1.7 billion people don’t have a bank account.
Thanks to their accessibility, cryptocurrencies can promote financial inclusion around the world. The use of cryptocurrencies offers an opportunity for financial inclusion for disadvantaged and unbanked populations, one billion of whom own a mobile phone. Thus, it can be argued that cryptocurrencies are inherently good for the economy.
How do cryptocurrencies protect against inflation?
The answer to whether cryptocurrencies and BTC in particular offer inflation protection may come down to attitude. Some choose to use only well-protected stablecoins.
Cryptocurrencies like BTC have traditionally been seen as a hedge against inflation. The limited supply and decentralized nature of BTC is thought to contribute to the increase in value of readily available BTC and BTC that have yet to be mined over time.
Falling cryptocurrency prices and high inflation rates may lead some to question whether BTC lives up to high expectations of financial inclusion and inflation protection. You may want to distinguish between “owning” BTC and “using”. Is BTC seen as a means of payment that potentially serves the needs of the real economy or is it seen as an investment vehicle as a safe haven from inflation? Depending on the answer, it can be analyzed whether cryptocurrencies serve as a hedge.
Alternatives are also important. Some choose to use only well-protected stablecoins. And whether cryptocurrencies are viable ways to escape rising inflation depends on whether they are seen as real alternatives to (failed) monetary policy. A BTC maximalist might argue that allowing for a fixed money supply after 1971 and certainly after 2008 proved inadequate for the needs of the real economy. The staggering inflation rates around the world are undeniably increasing the curiosity and need for cryptocurrencies.
The advantages of cryptocurrencies over fiat and their usefulness are particularly significant in countries that have experienced a devaluation of 50% or more against the US dollar (over the past decade). Think Venezuela, Lebanon, Turkey, Suriname or Argentina. People living in these countries were five times more likely to say they intend to use cryptocurrencies than people with inflation below 50% over the same period.
Are there any problems with cryptocurrencies?
There are stories about cryptocurrencies highlighting their use for criminal activity, their alleged harmful effects on the environment (and associated financial consequences), and the volatile nature of cryptocurrencies.
Just like cash, it’s no surprise that some (cyber)criminals use cryptocurrencies. Interestingly, the growth of legal use of cryptocurrency far exceeds criminal use, the share of illegal activities in the number of cryptocurrency transactions is very low, as transactions related to illegal addresses accounted for only 0.15 % of the number of cryptocurrency transactions in 2021.
Next, cryptocurrencies are said to be bad for the environment. More specifically, BTC’s Proof of Work (PoW) consensus mechanism would have negative impacts (environmental and economic). However, valuation studies show that BTC is responsible for 0.08% of global carbon dioxide emissions, and in return, BTC powers an entire industry and the financial inclusion of millions of people around the world.
Another downside is that most cryptocurrencies survive: volatility. As a result, some currencies can rapidly lose value. Economists who tend to look at “money” through a traditional lens might argue that cryptocurrencies are therefore not suitable as a means of payment and that users are at greater risk.
Economists may also argue that the value of cryptocurrencies is not guaranteed because no commercial or central banks participate. An economist might think that a central bank digital currency (CBDC) might be a good solution because the administration remains in the hands of the central bank.
Can Cryptocurrency Survive the Economic Downturn?
Cryptocurrency prices, industry development, and innovation enhance each other through a positive feedback loop, despite the temporary cryptocurrency winter.
The downward pressure in the cryptocurrency markets may be related to shifts in traditional markets and geopolitical factors. Cryptocurrency investors are having a tough time. The economic situation has changed considerably. High inflation, for example, causes central banks to adjust their policies: they raise interest rates and thus tighten financial markets. Rising interest rates, for example, make investing in bonds more attractive.
When the stock market undergoes a correction, risk averse strategies also undermine cryptocurrency investments. It is often said that the cryptocurrency winter is approaching, which is seen as similar to the bear market cycle in the stock market, but in terms of digital asset prices in the cryptocurrency market. Winter brings some painful (individual) effects. For example, some cryptocurrency-related companies have cut costs by laying off.
The correlation of cryptocurrency market capitalization with traditional markets suggests institutionalization, but that’s not necessarily a bad thing. It demonstrates that adoption and acceptance are the first steps towards wider adoption of cryptocurrencies and their underlying technical foundations.
Indeed, prominent opinion leaders argue that cryptocurrency markets move in cycles, and those cycles can appear chaotic from an outside perspective. But there is actually a logic behind it, where prices, industry development and innovations are connected as a positive feedback loop.