The increasing inflation rate across the globe has caused investors to seek possible means for hedging their capitals against inflations. Many traders today now find risky assets especially crypto as their way of hedging against inflation. While crypto investment could be rewarding over time, yet the risk associated with this investment is so high that the investor could lose all his capital in cases when he makes the wrong investment. Many crypto projects too have crashed in the past and brought so much loss to investors. This has led investors to raise such questions as: Can crypto be considered the best hedge against inflation? What are the risks associated with using crypto to hedge against inflations? This work will help you find some answers to these pressing questions.
What is hedging?
Hedging is a capital protection strategy that involves taking two different positions in the market to protect the initial position should the market go against the forecast. This strategy involves buying and selling an asset simultaneously to protect the initial position. For instance in CFD trading which involves so much risk, traders try to hedge their positions to protect their capitals by taking two sides in the market. This involves buying and selling a financial asset at the same time.
Thus, a trader could take a “long” position for EURUSD at $1.01260 and then set a pending “Short” position for this same pair at $1.01020. This means when the market fails to long as he predicted, his “short” orders will trigger to protect his previous long positions.
Another way of hedging is to purchase two different assets whose prices are opposed to each other. For instance, the US dollar is opposed to every other asset tied to it including Stocks, Commodities, Crypto, etc. The investor who has made some investments into the US dollar can decide to invest in these assets pegged to the US dollar to protect his position should the US dollar weaken.
Meaning of Inflation
Inflation is the loss of value for a given currency as a result of having so much amount of currency in circulation. When there is too much money chasing a few goods and services in the market then, prices skyrocket and the currency depreciates. A lot of factors can cause inflation. For instance; when the Central Bank mints new currencies or when the government gives massive loans or free money to the citizens as we saw during the COVID-19 pandemic, and so on.
Is Crypto the best hedge for Inflation?
One of the ways investors tried to hedge against inflations is to invest in Crypto. Given the volatile nature of most crypto assets, crypto traders try to preserve the value of the capital by purchasing different Cryptocurrencies they feel that their prices could increase over time. For instance, the trader who has $1,500 capital, could proceed to buy Ethereum in 2022 when the price was at $1,500. He then waits to sell it when the price gets to $2,500. With this, he shall have increased the value of his money by $1,000 over time. This will enable him to have the same value for his money even if prices of goods and services increased as a result of inflation.
However, one major risk associated with using crypto to hedge against inflation is that prices could as well depreciate over time. This is because the crypto market runs in seasons hence, we have the bearish and bullish seasons. Often some crypto projects crash during the bearish season which increases the investor’s risk while hedging with crypto.