What is the impact of cryptocurrencies on the economy?

Cryptocurrency is far more than just a financial innovation — it’s a social, cultural and technological form of progress. Through its accessible character, cryptocurrencies have the potential to spur the economy immensely. 

Cryptocurrencies are digital assets managed with cryptographic algorithms. There are different types of cryptocurrencies. Bitcoin (BTC) is probably the most well-known cryptocurrency, but thousands of others have emerged over time. Naturally, these also include stablecoins, cryptocurrencies whose value is pegged to, for example, a fiat currency, debt paper or commodities like gold. 

When cryptocurrency prices are correcting and the fear and greed index bounces, it is important to take a breath and grasp that the wider impact of cryptocurrencies goes beyond daily price fluctuations. Cryptocurrency use cases and their underlying blockchain technologies are being developed at an exponential speed. The tremendous economic impact of cryptocurrencies on the global economy cuts through sectors across national boundaries and goes beyond what was impossible not that long ago. 

Cryptocurrencies have pros and cons, like any tool or technology. The positive impacts of cryptocurrency are profound. One of the greatest advantages is arguably accessibility. With cryptocurrencies, one can pay or get paid without the intervention of third parties such as banks. The status quo of the current financial system has arguably failed many individuals globally. Indeed, more than 1.7 billion people don’t have bank accounts

Due to their accessibility, cryptocurrencies may spur financial inclusion globally. For underserved and unbanked populations — one billion of whom have mobile phones — the use of cryptocurrencies offers a shot at financial inclusion. Therefore it can be argued that cryptocurrencies are inherently good for the economy.

How does crypto protect from inflation?

The answer to whether cryptocurrencies and specifically BTC, protect from inflation may depend on your stance. Some may choose to only involve themselves with well-backed stablecoins.

Cryptocurrencies like BTC have traditionally been considered hedges against inflation. The capped supply of BTC and its decentralized nature have been believed to contribute to the increasing value of readily available BTC and those yet to be mined over time. 

Falling cryptocurrency prices and high inflation rates today may make some wonder whether BTC delivers to the high expectations of 𝐟𝐢𝐧𝐚𝐧𝐜𝐢𝐚𝐥 𝐢𝐧𝐜𝐥𝐮𝐬𝐢𝐨𝐧 and hedging against inflation. One may want to distinguish between “owning” BTC and “using” it. Does one consider BTC as a means of payment, potentially meeting the needs of a real economy or does one see it as an investment vehicle as a haven against inflation? Depending on that answer, one can analyze if cryptocurrencies work as hedges. 

The alternatives matter, too. Some may choose to only involve themselves with well-backed stablecoins. And, whether cryptocurrencies are valid ways to flee from rising inflation depends on if one considers them true alternatives to (failing) monetary policy. A BTC maximalist may argue that allowing for a non-fixed money supply, post-1971 and certainly post-2008, has proven to not match the needs of a real economy. Staggering inflation rates globally arguably spur the curiosity about and need for cryptocurrencies. 

The benefits of cryptocurrency over fiat and their utility are especially significant in countries suffering 50% or more devaluation against the U.S. dollar (over the last ten years). Think Venezuela, Lebanon, Turkey, Surinam or Argentina. Individuals living in those countries were more than five times as likely to say that 𝐭𝐡𝐞𝐲 𝐩𝐥𝐚𝐧 𝐭𝐨 𝐮𝐬𝐞 𝐜𝐫𝐲𝐩𝐭𝐨 compared with those who experienced less than 50% inflation over the same period.

Are there any problems with cryptocurrency?

There are narratives about cryptocurrencies that highlight their use for criminal activities, their supposedly harmful impact on the environment (and the economic impacts related to it) and cryptocurrencies’ volatile nature.

Much like cash, it’s no surprise that some (cyber) criminals use cryptocurrency. Interestingly enough, with the growth of legitimate cryptocurrency usage far outpacing the growth of criminal usage, illicit activity’s share of cryptocurrency transaction volume is very low, as transactions involving illicit addresses represented just 0.15% of cryptocurrency transaction volume in 2021. 

Next, cryptocurrencies are said to be bad for the environment. Specifically, BTC’s proof of work (PoW) consensus mechanism is said to cause negative (environmental and economic) impacts. However, estimating studies show that BTC contributes 0.08% t to global co2 emissions. In return, BTC spurs a whole sector and the very financial inclusion of millions of people globally.

Another disadvantage is that most cryptocurrencies cope with: volatility. As a result, some currencies may quickly lose their value. Economists, who tend to look at “money” through a traditional lens, may argue that cryptocurrencies are thus unsuitable as a means of payment and that users run greater risks. 

Economists may also argue that the value of cryptocurrencies is not guaranteed because of the lack of commercial or central bank involvement. An economist may hold that a central bank digital currency (CBDC) can be a good solution because governance remains in the hands of the central bank.

Needless to say, the cryptocurrency markets can be extremely volatile and chaotic indeed, but zooming out there appears to be an underlying logic at work. Looking at the logarithmic chart of BTC (see below) instead of its linear chart, for instance, it shows that volatility and drawdowns have remained fairly consistent over time.

Will cryptocurrency survive an economic recession?

Cryptocurrency prices, industry developments and innovation are arguably enhancing one another through a positive feedback loop, despite the temporary crypto winter. 

The downward pressure in the cryptocurrency markets may correlate with the slipping of traditional markets and geopolitical factors. Cryptocurrency investors go through difficult times. The financial climate has changed considerably. High inflation, for example, is causing central banks to adjust their policies: They raise interest rates and thus ensure a tighter financial market. The rising interest rates make it more interesting to invest in bonds, for example. 

When the stock markets suffer a correction, risk-aversion strategies are also toning down cryptocurrency investments. It is often stated that crypto winter is approaching, understood as something similar to a bear market cycle in the stock market but then regarding the prices of digital assets on the crypto markets. The winter goes along with some painful (individual) effects. For instance, some crypto-related companies have been cutting their costs through layoffs. 

The cryptocurrency market capitalization being correlated with the traditional markets indicates institutionalization, but that is not necessarily bad. It indicates adoption and acceptance as the first steps toward broader acceptance of cryptocurrencies and their underlying technological foundation. 

Indeed, prominent thought leaders argue that the cryptocurrency market develops in cycles and that those cycles can appear chaotic from an external point of view. But, in reality, there is an underlying logic in which prices, industry developments and innovation are connected to one another in a positive feedback loop.

How do cryptocurrency investments impact the broader crypto-economy?

Although the cryptocurrency market appears to grow in a positive feedback loop, that does not mean that (un)expected events may not impact the trajectory of the ecosystem as a whole. 

Although blockchain and cryptocurrencies are fundamentally meant as ‘trustless’ technologies, trust remains key there where humans interact with one another. The cryptocurrency market is not only impacted by the broader economy, but it may also generate profound effects by itself. Indeed, the Terra case shows that any entity — were it a single company, a venture capital firm or a project issuing an algorithmic stablecoin — can potentially set into motion or contribute to a “boom” or “bust” of the cryptocurrency markets. 

The impact of such crypto-native events with systemic impact mirroring traditional finance domino effects, and the consequential falls of Celsius and Three Arrows Capital, all indicate that the crypto-economy is not immune to failures. Indeed, while traditional finance has institutions that are too big to fail, the crypto sector does not.

Looking in retrospect is always easy, but the Terra project was fundamentally flawed and unsustainable over time. Nevertheless, its downfall had a systemic impact as many projects, venture capital and standing companies were exposed and heavily impacted. It indicates that investing in cryptocurrencies is all about thinking about risks and potential rewards. 

The fall and domino effect across the board indicate the lack of maturity of the very sector itself. 

Since innovation and prices are inherently connected and the early-stage development of the crypto-economy offers lots of untapped potential, the said economy may continue to see events that temporarily undermine growth. 

Yet, many working in the sector have a “trustless” conviction that strong projects will keep up during temporary corrections and that the cryptocurrency winter will clean up the path for a cycle of unlimited, novel disruptive innovation.

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