Cryptocurrencies are supposed to protect their holders against fiat money debasement. That’s one of the central tenets of the bull case for Ethereum (CCC:ETH-USD), Bitcoin (CCC:BTC-USD) and other leading cryptos.
In a way, crypto is supposed to be precious metals of the 21st century. Gold and silver have long served as defense against hyperinflation across human history. Be it ancient Rome, or modern Venezuela and North Korea, gold has served as a reasonable hedge against failing currencies.
Bitcoin, with its premise that only 21 million would ever be created, has the same sort of deflationary ethos. In a world of reckless human money printing, aren’t Bitcoin and Ethereum safe havens from the storm? Despite the strong intellectual argument, crypto has been failing to hold up its end of the bargain in recent months as inflation has taken off. Here’s why.
Most Traders Aren’t Buying It For Inflation Protection
If you read social media or Discord groups about cryptocurrency, most of it is about fast money trading. What altcoin is going to pump next. Which non-fungible token (NFT) project is going to get influencers on board soon. And so on. It’s all fast money sloshing around looking for the next big score. And, to be clear, there’s nothing wrong with that. However, the mentality is one of getting rich quick; making a fortune from a newly-emerging ecosystem.
By contrast, most of the buyers of gold and silver are institutions, pensions, central banks and other cold-blooded capital allocators. They measure their holding times in decades. For them, precious metals are a hedge against the worst of humanity.
If and when institutions buy into Ethereum and other cryptos, it will be as a generational holding designed to produce safe compounding of capital over the long-term. However, so far, crypto hasn’t proven stable enough to serve as a serious asset class for most central banks or large financial institutions.
Crypto Is Highly Correlated To Growth and Meme Equities
On Wednesday, the U.S. announced consumer price inflation (CPI) of 7%, which was one of its highest readings since the 1970s. In theory, crypto should be surging if it were a monetary asset like gold.
However, I’d argue it’s far closer to a speculative asset like special purpose acquisition companies (SPACs), SaaS stocks, and meme names. It’s probably no coincidence that so many of the diehard holders of GameStop (NYSE:GME) and AMC (NYSE:AMC) are also big on Ethereum, Dogecoin (CCC:DOGE-USD) and NFTs.
The same rebellious spirit applies to both groups of assets. People own AMC because they don’t believe in Wall Street or traditional brokerages and trading houses. They want to crush firms such as Citadel. Owning crypto is a sign of disbelief in the U.S. Dollar, the Federal Reserve, and the government’s ability to manage the economy.
Contrarian investing is a fine thing. But it’s a different breed of finance than making a straight macroeconomic play as traditional gold and silver investing has been through the years.
Crypto’s Dirty Secret: Excess Printing And Unit Creation
It’s true that the major cryptos such as Bitcoin have a limited supply of units. There will only be 21 million Bitcoins, ever. Ethereum doesn’t have a similar hard cap, though there is a strict limit on the amount of new Ether issued in any given year. Over time, such as with the switch to Ethereum 2.0, the creation rate of new coins may be further limited. It’s coded into ETH that its inflation rate will be low.
So, what’s the issue? Two things. One, there’s no way to limit the amount of rival new cryptocurrencies. Over the past year, cryptos such as Solana (CCC:SOL-USD) and Shiba Inu (CCC:SHIB-USD) emerged from obscurity to become leading cryptos by market capitalization. Some of these will last longer than others; Solana has a much more promising future than Shiba Inu, for example.
Regardless, the creation of each new rival token diminishes the utility and value of older projects such as Bitcoin, Ethereum, and Cardano (CCC:ADA-USD). As any economics textbook will tell you, when you create more supply, it creates a new equilibrium at a lower price. As long as the supply of new cryptocurrencies is virtually infinite, it will be hard for consumers to trust in the long-term value of existing tokens.
Another issue is Tether and other so-called stablecoins. These exist to allow traders to cash out of crypto plays without having to move money into fiat currency. However, stablecoins now appear to be used to prop up market prices. A few years ago, there were fewer than one billion Tether in existence. Now there are $78 billion worth of Tether.
There is a great deal of debate over what exactly backs these $78 billion. In any case, it doesn’t appear to be actual dollars. What happens when you have a thinly-capitalized institution of questionable repute backing up the value of your assets? Sounds a lot like fiat banking, right? Ironically, cryptocurrency investors have traded the Federal Reserve for Tether’s backers. That’s not necessarily a good trade.
It’s become increasingly clear over the past six months or so that cryptocurrency is another growth asset. It acts, in most regards, like FAANG stocks, software companies, or other growth ventures. If the overall flow of capital going into growth assets increases, Ethereum and other leading currencies should rise. However, if the slump in growth vehicles continues, ETH will keep on dropping.
This runs contrary to the expectation that crypto was supposed to act as in correlation to inflation. However, crypto just isn’t an inflation hedge as it currently operates. Its traders buy it for quick gains, not as a wealth preservation vehicle. Also, the crypto ecosystem is rife with inflation of its own, both in its new unit creation and its stablecoins.
The fact that staking operations often yield 10%+ annually in crypto speak to the huge levels of inherent inflation and volatility in Ethereum and other leading crypto ecosystems. This doesn’t necessarily make crypto a bad investment. But please don’t buy it thinking it is going to protect against rising consumer prices. A trade in Ethereum is a bet on something else entirely.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a sizable New York City-based hedge fund. You can reach him on Twitter at @irbezek.