How High Inflation Drives Countries Towards Crypto

What is CryptoCurrency?

A cryptocurrency (aka. Crypto), is an alternative form of payment created electronically rather than through government fiat (decree). The idea behind it is that an algorithm creates a limited amount of currency that is available to individuals to use instead of cash, checks or credit cards. The technology behind it allows you to send it directly to others without going through a 3rd party like a bank.

Initially, the untraceable nature of cryptocurrency led governments to suspect that it was being used for nefarious purposes. And some notable cases of purchases on the “dark web” were prosecuted like the “Silk Road” case which operated from 2011-2013.

Since then cryptocurrency has become more popular overall, but there are certain locations around the world, where adoption has surged. Countries which have recently experienced economic policies resulting in inflation and hyperinflation have seen their residents turn to cryptocurrency as an alternative to their rapidly depreciating home currency.

As we mentioned in “Gold Price and Its Relationship with Inflation” – “In some instances when inflation gets bad enough (i.e. hyperinflation) the entire economy will switch to accepting an alternative currency just as Zimbabwe began accepting U.S. dollars in preference to their own currency.” This switch to a more reliable form of wealth storage could be another country’s currency such as the U.S. Dollar, Gold, or even Crypto.

There are several important characteristics that a medium of exchange must have.

1) Durability- Money must last. Fish have been tried as a medium of exchange but they don’t last. No one wants to accept a rotten fish in trade for a fresh loaf of bread.

2) Portability- You have to be able to transport your money. It would be difficult to pay for things if you can’t carry it with you. The official currency of Micronesia is the US dollar, but the island state of Yap uses an additional form of money: limestone discs, some of which weigh more than a car. These would not make good currency in modern society.

3) Divisibility- You have to be able to “make change”.

4) Uniformity- The currency has to be uniform. In other words, people need to be able to easily recognize that it is money and the value of each denomination.

5) Limited Supply- If there is too much of it, it won’t be valuable. Sand would make a poor currency.

6) Acceptability- People have to find it acceptable. Once again, who wants to carry around rotten fish in their pocket?

What Causes Inflation?

In our article, What is the Real Definition of Inflation? we explained that there is a major difference between the cause and the effect of Inflation and unfortunately both are loosely called “Inflation”. More accurately the cause is “monetary inflation” (i.e. an increase in the money supply) and the effect is “Price Inflation” (i.e. an increase in the cost of goods and services). When the supply of money gets out of control and becomes inflationary, it threatens the 5^th law of money and that is a limited supply.

Even at lower levels of inflation like 5%, consumers tend to try to spend faster rather than holding on to the currency and allowing it to depreciate. This increases the Velocity of Money which also fuels inflation because people are willing to buy things (anything even at a higher price) rather than hold on to the depreciating money. This becomes a positive feedback loop which can easily become hyperinflation.

So the primary cause of inflation and then hyperinflation is poor Central Bank policy by “creating too much supply” of a currency. Often it isn’t the Central Banks fault because the Government is spending more than it gets in so those in charge order the Central Bank to print more money to pay the bills.

Hyperinflation isn’t as uncommon as you might think. The following chart shows 19 countries with hyperinflation in the relatively short period from 1967 through 2011.

During this time Crypto wasn’t an option yet so citizens would often substitute precious metals or currencies from other countries. At that point, the failing regimes often resort to draconian legislation that institutes price controls and currency controls to try and maintain order. This always eventually fails as the stresses on the system get greater and shop keepers can’t afford to sell at the controlled price so shelves become empty. See: Civil Liberties Rest Upon Sound Money

In more recent times, countries have turned to Crypto, such as Argentina, and Venezuela as an alternative to their local currency. In the case of Venezuela, the government tried creating their own cryptocurrency but obviously, that won’t work since they still controlled the levers of supply. See: Can Crypto Solve Venezuela’s Hyperinflation Problem?

How Does Crypto Help?

There is a reason why people who reside in totalitarian countries suffering from hyperinflation quickly turn to crypto and open a bitcoin wallet. One is the privacy factor. Just as those on the dark web wanted to conceal their activities from the government, when the government becomes corrupt even law-abiding citizens find it necessary to turn to “black market” activities in order to survive. In Venezuela, for instance, the price-controlled shelves are empty of necessities like bread, toilet paper, and milk. But if you have another currency (like U.S. dollars or Crypto) shop keepers “magically” find a supply of goods to sell you. One advantage of Crypto is that it is more easily concealed than dollars and the transactions are handled electronically.

Cryptocurrency offers an escape like foreign currency does in these moments. When economic turmoil occurs, citizens can start buying crypto to store their savings and protect their money. It becomes a borderless currency that they can count on in times of inflation.

One of the concerns of crypto voiced by many is its volatility. As a new medium of exchange, it has been difficult for the market to rightly assess its value. That combined with speculation has resulted in excessive exuberance causing high volatility. Hopefully, as Crypto matures that volatility will calm down. In the meantime, people with guaranteed losses in their home currency are willing to take a chance that Crypto will be more stable than the local fiat currency.

Examples of Countries Turning to Crypto

Here are some recent examples that people are rallying behind crypto specifically in places suffering hyperinflation.

Argentina has repeatedly suffered from hyperinflation. Apparently, it doesn’t matter who is in charge of the government they always seem to spend more than they have. As recently as March 2019 their inflation rate has been around 34%.
Venezuela – local people here have experienced dramatic hyperinflation on necessities and simultaneously are demanding Bitcoin Cash at unbelievable rates. Venezuela’s Inflation rate is Projected to Hit 10,000,000% in 2019.
Turkey – the local lira has been in decline for some time against a host of other fiat currencies. During this decline, Turkish people and residents of Turkey are turning to Bitcoin. Turkey’s inflation rate is around 20%.

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What is CryptoCurrency?

What Causes Inflation?

How Does Crypto Help?

Examples of Countries Turning to Crypto

About Tim McMahon

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