economy

Don't get excited about Fed 'dovishness' — another rate hike is in the cards

Contrary to Jerome Powell’s intimations, inflation is likely to rise in the months ahead. If the Fed does not hike rates in 2024, the problem will get worse.

December’s Federal Open Market Committee (FOMC) meeting was a huge boon for markets. Risk assets — including cryptocurrencies — soared as the central bank appeared to take a more dovish stance on monetary policy. But the markets may be in for a nasty surprise in 2024 as the Federal Reserve faces an uphill battle against price increases, which may well force policymakers to hike again to reach their 2% inflation target.

The overwhelming expectation right now is that the Fed has won its battle against inflation. However, this is not what economic analysis shows. In fact, the recent slowdown in price growth is very likely to prove temporary — with inflation soaring again next month to finish the year around 3.5%, and remaining sticky well into 2024. This will be problematic for the central bank, whose dual mandate stipulates it must control prices while maintaining maximum employment.

So far, it has certainly succeeded with the latter. Unemployment remains at historically low levels, dropping from 3.9% in October to 3.7% in November. The economy added 199,000 jobs that month, beating analysts’ expectations. Wage growth also continued to outstrip inflation for the fifth month in a row in October, rising again to 5.7% after a brief hiatus.

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How does the economy work?

The economy is a system of producing and exchanging goods and services in a society.

The economy is a complex system of production, distribution, and consumption of goods and services. Understanding how the economy works can be challenging, but it is essential for making informed decisions about personal finance, investing and public policy.

This article will explore the fundamental concepts of how the economy works, including the factors that influence it and the various components that make up the economy.

Factors that influence the economy

The economy is a dynamic system that is constantly changing and evolving. It is a vast network of people, organizations and governments; each involved in creating, moving, and using commodities and services. The economy is influenced by a wide range of factors, including macroeconomic factors like government policies, interest rates and international trade, as well as microeconomic factors such as individual decisions about spending and saving.

Government policies

Through its policies, the government significantly impacts how the economy develops. Fiscal policy, for instance, describes how the government uses spending and taxation to affect the economy. The government can stimulate the economy or deflate an overheated one using its purchasing power. Taxation is another tool the government can employ to manage the money supply and affect the level of economic activity.

Interest rates

The cost of borrowing money is represented by interest rates, which impact both consumer spending and company investment. Borrowing money is less expensive when interest rates are low, which can promote economic growth. High interest rates make borrowing more costly, which can stifle economic growth.

International trade

International trade also plays a crucial role in the economy. Trade between countries allows for the exchange of goods and services, which can increase economic growth and efficiency. However, trade can also lead to job losses in certain industries and countries, and imbalances in the trade deficit.

Components of the economy

The economy comprises three primary components: households, businesses and government. Each of these components plays a vital role in the economy and interacts with the others in complex ways.

Households

Households are the consumers of goods and services. People use the money they earn from employment or investments to pay for goods and services from companies. Due to the fact that household spending makes up a sizable share of the demand for goods and services, it has a considerable impact on economic growth.

Businesses

Businesses are the producers of goods and services. To create items and services sold to consumers or other businesses, they employ staff and invest in inputs like raw materials, equipment and technology. Business investment is critical to economic growth since it boosts productivity and creates jobs.

Government

The government plays a crucial economic role through its policies and spending. The government provides essential public goods and services such as education, healthcare and infrastructure, and it also regulates the economy to ensure fair competition and protect consumers.

Economic indicators

Several economic indicators are used to measure the health of the economy. These indicators provide insight into the level of economic activity, and can help individuals and policymakers make informed decisions.

Gross domestic product (GDP)

GDP is the total value of goods and services produced in a country over a specified period — usually a year. GDP is one of the most widely used economic indicators and provides a broad measure of economic activity.

Unemployment rate

The unemployment rate is the proportion of the labor force that is unemployed but actively looking for work. It is an important indicator of the labor market’s health and sheds light on the level of economic activity. High unemployment rates indicate a low labor market and a low level of economic activity. In contrast, low unemployment rates indicate a strong labor market and a high level of economic activity.

Inflation rate

The inflation rate gauges how quickly the average cost of goods and services is rising across an economy. Several causes, like a growth in the amount of money in circulation or a rise in the demand for goods and services, can contribute to inflation. Low inflation rates might signal sluggish economic growth, whereas high inflation rates can signal an overheated economy.

Related: How to preserve capital during inflation using cryptocurrencies?

Consumer Price Index (CPI)

The CPI measures the average price of a basket of household goods and services. It is used to track inflation over time and to adjust for changes in the cost of living. The CPI is an important indicator of consumer spending patterns, providing insight into the economy’s health.

Retail sales

Retail sales are a measure of the total amount of goods sold by retailers over a specified period. Retail sales can be a good indicator of consumer spending patterns. High retail sales indicate a strong economy, while low retail sales suggest weak economic activity.

Industrial production

Industrial production measures the total output of the industrial sector of the economy, including manufacturing, mining and utilities. It is an important indicator of the health of the manufacturing industry — a critical component of many economies.

Housing starts

The number of new residential construction projects that have started over a specific period is called housing starts. They are a crucial gauge of the housing market’s health and the state of the overall economy. Low numbers of home starts can signify sluggish economic activity, while high levels can suggest significant economic growth.

How does blockchain affect economic growth?

Blockchain technology has the potential to significantly impact economic growth in several ways. By enabling secure and efficient transactions, reducing costs, and increasing transparency and trust, blockchain can promote innovation, productivity and financial inclusion. 

Related: How blockchain empowers women in developing economies

In addition, blockchain-based apps can produce fresh company models and sources of income, stimulating the economy and opening up job prospects. Because blockchain technology is still in its early stages of development and adoption, the total influence of this technology on economic growth has not yet been realized.

Yet, the ability of blockchain to revolutionize many businesses and sectors — from logistics and supply chains to finance and healthcare — makes it a viable tool for promoting economic growth in years to come.

TradFi and DeFi come together — Davos 2023

On this episode of Decentralize With Cointelegraph, the team reflects on their week in Davos covering the World Economic Forum as crypto and TradFi continue to collide.

Traditional finance, or TradFi, continues to explore the world of cryptocurrencies and blockchain technology, with the World Economic Forum holding more workshops and sessions for the sector in 2023. These were major themes seen by the Cointelegraph team as they covered the action throughout a busy week in Davos, Switzerland. In a late-night recording session, the team recapped everything readers need to know about the week for the new Decentralize With Cointelegraph podcast.

Cointelegraph editor-in-chief Kristina Lucrezia Cornèr reflected on her access inside the WEF compared with previous years in Davos. She also unpacked the ongoing synergies between traditional finance and decentralized finance, or DeFi, that were evident from the myriad crypto industry events taking place. Cointelegraph journalist Gareth Jenkinson was tasked with covering these crypto meet-ups, which took place at a number of shops refurbished for events down the central promenade in Davos.

Speaking to a number of industry insiders and TradFi participants, Jenkinson highlighted the ongoing cross-pollination between the sectors, while just a handful of crypto participants were involved in conversations inside the World Economic Forum.

From JPMorgan Chase CEO Jamie Dimon’s renewed skepticism toward Bitcoin (BTC) to the Cointelegraph team nearly getting stranded due to frozen diesel in their gas tank, Davos 2023 proved to be an entertaining and educational journey.

Davos has long been the spiritual home of the World Economic Forum, but recent years have seen a number of crypto and blockchain firms, projects and events rent space along the central road that runs to the WEF conference compound.

While crypto proponents mixed with TradFi members and curious visitors from both public and private institutions on the promenade, just a handful of crypto-related institutions took part in workshops inside the WEF.

Cointelegraph editor-in-chief Kristina Lucrezia Cornèr (right) on stage with Rhett Power (left), Forbes columnist, hosting Webit Founders Games in Davos during WEF 2023. Source: Cointelegraph

Cointelegraph spoke with representatives from Circle and Ripple, who gave an inside view into the WEF’s changing perception toward the sector, while the heads of metaverse platforms The Sandbox and Upland also touched on the different perceptions both inside the WEF and outside of its walls.

Related: Cointelegraph heads to Davos for World Economic Forum

There seemed to be general consensus that the crypto and blockchain space was becoming increasingly talked about at the WEF, with the number of workshops and discussions on the sector increasing from May 2022.

Cointelegraph reporter Gareth Jenkinson (right) with Brooks Entwistle (left), APAC managing director at Ripple. Source: Cointelegraph

Nevertheless, the co-mingling of TradFi and DeFi proponents was clear to see. Conventional investment funds, hedge fund managers and banks all drove discussions around cryptocurrency adoption and custody at the events Cointelegraph attended and moderated.

To hear Cornèr and Jenkinson reflect on changing perceptions and increased conversations between the old guard of traditional finance and the innovative cryptocurrency and blockchain ecosystem, listen to the first episode of Decentralize With Cointelegraph on Cointelegraph’s newly launched podcasts page — and be sure to check out the additional lineup of new shows. The episode is also available on Spotify.

Bitcoin price rally to $18K possible as $275M in BTC options expire on Friday

Bitcoin bulls aim to push BTC price to $18,000, and options data outlines clear reasons why.

Bitcoin (BTC) price jumped to $17,500 on Jan. 11, driving it to its highest level in three weeks. The price move gave bulls control of the $275 million BTC weekly options expiry on Jan. 13, as bears had placed bets at $16,500 and lower. 

The recent move has permabulls and dip-buyers calling a market bottom and potential end to the bear market, but what does the data actually show?

Is the Bitcoin bear market over?

It might seem too pessimistic to say right now, but Bitcoin did trade below the $16,500 level on Dec. 30, and those bearish bets are unlikely to pay off as the options deadline approaches.

Investors’ main hope is the possibility of the U.S. Federal Reserve halting its interest rate increase in the first quarter of 2023. The Consumer Price Index (CPI) inflation report will be released on Jan. 12, and it might give a hint on whether the central bank’s effort to slow the economy and bring down inflation is achieving its expected results.

Meanwhile, crypto traders fear that an eventual downturn in the traditional markets could cause Bitcoin to retest the $15,500 low. For instance, Morgan Stanley’s chief investment officer and chief U.S. equity strategist, Mike Wilson, told investors on CNBC to brace for a winter downdraft and warned that the S&P 500 index is vulnerable to a 23% drop to 3,000. Wilson added, “Even though a majority of institutional clients think we’re probably going to be in a recession, they don’t seem to be afraid of it. That’s just a big disconnect.”

Cast your vote now!

Bitcoin bears were not expecting the rally to $17,500

The open interest for the Jan. 13 options expiry is $275 million, but the actual figure will be lower since bears were expecting prices below $16,500. Bulls seem in complete control, even though their payout becomes much larger at $18,000 and higher.

Bitcoin options aggregate open interest for Jan. 13. Source: Coinglass

The 1.18 call-to-put ratio reflects the imbalance between the $150 million call (buy) open interest and the $125 million put (sell) options. If Bitcoin’s price remains above $17,000 at 8:00 am UTC on Jan. 13, less than $2 million worth of these put (sell) options will be available. This difference happens because the right to sell Bitcoin at $16,500 or $15,500 is useless if BTC trades above that level on expiry.

$18,000 Bitcoin will give bulls a $130 million profit

Below are the four most likely scenarios based on the current price action. The number of options contracts available on Jan. 13 for call (bull) and put (bear) instruments varies, depending on the expiry price. The imbalance favoring each side constitutes the theoretical profit:

  • Between $16,000 and $16,500: 100 calls vs. 2,700 puts. The net result favors the put (bear) instruments by $40 million.
  • Between $16,500 and $17,500: 1,400 calls vs. 1,500 puts. The net result is balanced between bears and bulls.
  • Between $17,500 and $18,000: 4,500 calls vs. 100 puts. The net result favors the call (bull) instruments by $75 million.
  • Between $18,000 and $19,000: 7,200 calls vs. 0 puts. Bulls completely dominate the expiry by profiting $130 million.

This crude estimate considers the put options used in bearish bets and the call options exclusively in neutral-to-bullish trades. Even so, this oversimplification disregards more complex investment strategies.

For example, a trader could have sold a put option, effectively gaining positive exposure to Bitcoin above a specific price. But unfortunately, there’s no easy way to estimate this effect.

Related: Bitcoin gained 300% in year before last halving — Is 2023 different?

Bitcoin bears need to push the price below $16,500 on Jan. 13 to secure a potential $40 million profit. On the other hand, the bulls can boost their gains by slightly pushing the price above $17,500 to profit by $75 million.

The four-day rally totaled a 4.5% gain and liquidated $285 million worth of leverage short (sell) futures contracts, so they might have less margin required to subdue Bitcoin’s price.

Considering the uncertainty from the upcoming CPI inflation data, all bets are on the table, but bulls have decent incentives to try pushing Bitcoin price above $17,500 on Jan. 13.

The views, thoughts and opinions expressed here are the authors’ alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

Trouble brewing for the US: Two-thirds of TradFi expects a 2023 recession

According to recent research, major financial institutions tied to the Federal Reserve see the U.S. facing a “shallow” or “mild” recession in 2023.

The United States economy could be in for an upset. Data from a Wall Street Journal survey revealed financial experts expect the country to face an economic downturn this year.

Over two-thirds of economists at 23 major financial institutions that do business with the Federal Reserve believe the U.S. will have a “shallow” or “mild” recession in 2023. Two of the surveyed institutions predict a recession for the following year.

The research included big names in the financial services sector, such as Barclays, Bank of America, TD Securities and UBS.

Collectively, the Federal Reserve was named as the primary reason for the recession due to it raising interest rates to fight inflation. At the time of writing, the inflation rate in the U.S. is 7%, compared with the Fed’s target desired rate of 2%.

Additional factors contributing toward a potentially impending recession include pandemic savings being spent, a decline in the housing market and banks having more rigid lending standards.

The survey also found that many economists expect unemployment in the country to rise from 3.7% in November 2022 to above 5%, along with general economic contraction.

Related: 5 tips for investing during a global recession

However, Credit Suisse, Goldman Sachs, HSBC, JPMorgan Chase and Morgan Stanley all gave a rosier outlook on the situation, saying a recession will be avoided in both 2023 and 2024.

The state of the U.S. economy and the global economy have generally not seen the most positive predictions for the upcoming years. In October, Tesla and Twitter CEO Elon Musk said the global recession could last until the end of the year, near 2024.

Recurring global issues account for these bleak outlooks, such as widespread energy shortages and inflation.

Some experts in the decentralized finance space have spoken publicly on cryptocurrencies, particularly Bitcoin (BTC), as a hedge against monetary inflation.

5 tips for investing during a global recession

The market may be experiencing some tough days, but that doesn’t have to stop you from finding ways to prosper.

The economy is facing an outlook bleaker than a Welsh weather forecast, and few are rushing to buy risk assets. Here are a few tips for weathering unfavorable market conditions.

Option #1: Save cash

There’s no shame in sitting on the sidelines and saving cash or stablecoins.

When bullish momentum returns, you will have plenty of dry powder to make big allocations. In the meantime, there are still lots of opportunities to earn yield across crypto markets as long as you trust the protocol you’re using.

But isn’t this timing the market, which is impossible? Possibly. But this is more about spotting momentum and general market trends as opposed to more focused price targeting or calling reversals. Larger trends are easier to spot. However, if that’s a bit risky, there’s another option.

Option #2: Dollar-cost average (DCA)

Have you ever been to a physiotherapist with a wrist or back complaint? You’re hoping for a quick and easy cure, but instead, you’re given a sequence of trifling, tedious exercises to do daily for three months.

Well, dollar-cost averaging is the investing equivalent of that. It’s not sexy or even very interesting but it has a very high chance of working out in your favor given a long enough time horizon. And these days, there are automated bots that do it for you, so that helps.

​​Related: 5 reasons 2023 will be a tough year for global markets

These first two options could be combined to create a strategy. For example, putting 50% aside in stablecoins waiting for bullish momentum to return, and putting 50% into the market in a price-agnostic manner. This tactic allows for some exposure to the market, which can help in resisting FOMO when the market rallies, even though your overall thesis remains bearish.

Option #3: Find assets that outperform

Decentralized perpetual exchanges have been the darlings of the bear market. Following the FTX scandal, traders flocked to decentralized options, crying, “where can I short?” Many went to protocols such as GMX and ApeX, which are up about 70 and 50% this year, respectively.

There will always be assets that outperform during bear markets but finding them is labor-intensive and going long during a downtrend is risky. So this strategy should be approached with caution and is best used by investors with the nous and experience to spot a good project and apply solid risk management.

Option #4: Use derivatives

There are many strategies using derivatives and combinations of contracts to ensure profit in down-trending and sideways markets. For example, using options to create a “bear put spread” that allows you to make money when an asset falls by locking in a good selling price at a reduced rate.

There are also pseudo-delta-neutral strategies that advanced yield farmers use to long and short both sides of a liquidity pool. This reduces their exposure to the volatility of the assets they are holding so they can collect the pool fees while reducing their downside exposure.

The hard part is not so much actioning these strategies — there are instructions easily available online — but managing them and sizing your position. The management and position sizes can make or break these kinds of trades. They can be profitable in a bear market but should be used with caution.

Option #5: Keep your head on while others are losing theirs

Unless you’re a free climber like Alex Honnald, you wouldn’t attempt to scale any kind of cliff without good safety equipment. The same goes for crypto investing.

What safety equipment? Well, an emergency fund that is kept in cash is a good starting point. It should cover about six months of basic living expenses and shouldn’t be used for yield, borrowed against or staked.

Related: Bitcoin will surge in 2023 — but be careful what you wish for

You should also have a sinking fund, kept in similar circumstances (read: highly liquid) to pay for large expenses that crop up such as car repairs or, say, getting stuck in expensive Singapore for a week while your outgoing visa is delayed. The sinking fund will give you that extra buffer of support so you can keep your emergency fund pristine and use it for genuine emergencies only.

Finally, recessions are hard, so remember to go look after your mental health. If you are worried about your portfolio or constantly checking the price, then you are making yourself less healthy and reducing the chance you will make good decisions when the time comes. Therefore, go outside, turn off the computer and play around.

Develop your life outside your investing and trading activities. If you don’t do that, where will you go when you finally make it?

Nathan Thompson is the lead tech writer for Bybit. He spent 10 years as a freelance journalist mostly covering Southeast Asia before turning to crypto during the COVID-19 lockdowns. He holds joint honors in communication and philosophy from Cardiff University.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

What is stagflation, and how could it impact the cryptocurrency markets?

What is stagflation, how to fight it with crypto and how are the cryptocurrency markets impacted by high inflation and economic downturn?

What does stagflation mean for Bitcoin?

As stagflation goes alongside high inflation and economic downturn, BTC can be seen as a hedge against inflation and simultaneously as a risky asset whose price could fall during an economic decline.

BTC may be seen through the same lens as gold, which traditionally functioned as a hedge against inflation. Indeed, BTC could naturally be an excellent hedge against inflation. First, BTC is a decentralized global means of payment beyond the control of central authorities. Governments have no control over it, making it almost immune to potential corruption and monetary policy.

In addition, BTC is a scarce asset, as a maximum of twenty-one million can come into circulation and deflationary since the number of Bitcoin that goes into circulation halves approximately every four years. Because of this scarcity and finiteness, it is also called digital gold or a “store of value.”

In general, the prices of risky investments fall when interest rates rise. As the cryptocurrency market developed a significant correlation with the stock markets, much will depend on if and when BTC can break its correlation. This process will likely take time, also given institutional adoption.

Stagflation could be a catalyst for BTC and cryptocurrency adoption. This could happen if it turns out that the debt economy we build on is unsustainable. When Bitcoin is seen as an alternative or hedge against a failing financial system, prices and adoption can increase in economically uncertain times. A tipping point could come when public trust in BTC exceeds trust in the current economic system.

How to fight stagflation?

To fight stagflation, the government can implement monetary, fiscal and other policies that increase economic growth. Cryptocurrency may also prove to be a tool in itself.

The first tool is fiscal policy. Via an expansionary fiscal policy, one can increase government spending or decrease taxes to increase aggregate demand and stimulate economic growth. The government can cut spending to help reduce demand for goods and services, which could slow down inflation.

The second tool is monetary policy, which involves manipulating interest rates to try and stimulate the economy. Central banks use a low interest rate policy to decrease the cost of borrowing money. Interest policy can also reduce the amount of money in circulation to decrease the money supply, which may help boost economic growth over time.

The third tool is to try and reduce unemployment through active labor market policies. However, here there is the risk of built-in inflation, which refers to the demand for wage increases in the labor markets to meet the rising cost of living. Yet, this often results in businesses increasing the prices of goods and services to offset increasing wage costs.

If these measures fail, other options include raising tariffs or devaluing the domestic currency to make exports more competitively priced on foreign markets. Selling bonds or other financial instruments can decrease the money supply by taking that amount out of circulation.

Cryptocurrencies may also directly help fight stagflation by allowing people worldwide to participate in global trade without needing to go to a bank or a different institution. The increased access that people have to international markets can help improve global economic conditions and lead to more sustainable growth overall.

How does stagflation affect cryptocurrency markets?

Cryptocurrencies have not been around for very long. Hence, there is not much data yet on whether cryptocurrency is a good investment during stagflation and if stagflation is generally good or bad for the markets.

To grasp if cryptocurrency investments work well during stagflation, one can examine how traditional markets behave during inflation or stagflation and why. Stagflation is naturally bad for traditional markets, and as cryptocurrency markets have a high correlation with general indexes, meaning that negative sentiment can trickle into cryptocurrencies which are digital assets managed with cryptographic algorithms.

In general, investors who have their money in traditional instruments may be more willing to ride out periods of economic uncertainty than those who invest in cryptocurrencies that go along with higher volatility. During stagflation, there thus may be less demand for cryptocurrencies than usual.

Stagflation may also hurt cryptocurrency markets because it makes retail investors less interested in buying digital assets. After all, high inflation directly impacts how much money people have to purchase cryptocurrency, which is considered a more risky investment.

Yet, depending on one’s cryptocurrency investing strategy, one may choose to invest in these assets over traditional financial instruments. Cryptocurrencies run on a blockchain and are not tied to any particular country’s monetary policy like fiat currencies are. When inflation rises in one country but not another, investors can still capitalize on gains realized through cryptocurrency investments, even if their home currency loses value due to inflationary pressures.

Investors will often look for a way to protect their wealth from stagflation, especially in countries like Venezuela or Argentina, where hyperinflation occurs. Hyperinflation is when there is a speedy and uncontrollable price increase of vital goods and services in an economy. Here cryptocurrency investments work well during stagflation as they provide an alternative payment means and protect against hyperinflation. Individuals may choose to flee hyperinflation by re-directing some of their reserves into Bitcoin (BTC).

What causes stagflation?

Stagflation can be caused by an increased cost of living that outpaces consumer demand or production levels or a reduction in the gross domestic product, which can happen when a government imposes austerity measures. There are several other causes of stagflation, including supply shocks and monetary policy errors.

A supply shock is an event that causes prices to rise without any change in aggregate demand or companies’ inventory. These shocks can be provoked because of human actions. For example, a conflict between states may increase oil prices or another essential input into the production process, leading to cost-pull inflation, which is inflation due to an upsurge in the costs as a result of rising wages and raw materials.

Supply shocks can also include increases in prices due to natural disasters, leading to higher prices. Simply put, a change in the production process thus results in a decrease in the supply of goods or services, leading to demand-pull inflation, a specific type of inflation caused by supply shortages.

Monetary policy errors refer to how central banks manage their country’s money supply. Suppose they make too much money available for lending due to low interest rates. In that case, interest rates will fall, causing inflationary pressures on consumers’ wages and prices. However, with very high interest rates, a decline in economic activity may also result in stagflation.

What is stagflation?

Stagflation is a relatively rare phenomenon that may go alongside economic stagnation. Stagflation contrasts with inflation alongside economic growth, which occurs when prices increase alongside a higher output of the economy.

Economic stagnation occurs when the economy is not growing fast enough to meet the needs of its people. Stagflation is when the economy fails to develop and is also marked by high inflation. Stagflation can be seen as a contradiction because those circumstances usually do not coincide.

During stagflation, an economy grows so slowly that unemployment rises. Meanwhile, prices continue to increase as if companies sell everything they can produce. There is a smaller demand for goods and services, which may lead to even greater unemployment.

In an economy with high inflation rates, individuals do not know how much capital they will be able to spend in the future. Inflation makes it hard to plan and invest in the present because no one knows what their income will be after a certain amount of time. That causes even more uncertainty and slower growth. Thus, stagflation is a combination of two words: economic stagnation and inflation.

One of the most adequate examples of stagflation was during the 1970s, when several developed economies experienced slow economic growth, high unemployment and rising inflation due to global fuel shortages. Stagflation may also happen due to monetary or fiscal policy, such as when the United States decoupled its dollar from the gold standard in said period.

5 reasons 2023 will be a tough year for global markets

From inflation to energy shortages and general instability, markets are set for a turbulent year ahead.

Those who come bearing warnings are rarely popular. Cassandra didn’t do herself any favors when she told her fellow Trojans to beware of the Greeks and their wooden horse. But, with financial markets facing unprecedented turbulence, it’s important to take a hard look at economic realities.

Analysts agree markets face serious headwinds. The International Monetary Fund has forecast that one-third of the world’s economy will be in recession in 2023. Energy is in high demand and short supply, prices are high and rising and emerging economies are coming out of the pandemic in shaky conditions.

There are five fundamental — and interlinked — issues that spell trouble for asset markets in 2023, with the understanding that in uncertain environments, there are no clear choices for investors. Every decision requires trade-offs.

Net energy shortages

Without dramatic changes in the geopolitical and economic landscape, fossil fuel shortages look likely to persist through next winter.

Russian supplies have been slashed by sanctions related to the war in Ukraine, while Europe’s energy architecture suffered irreparable damage when a blast destroyed part of the Nord Stream 1 pipeline. It’s irreparable because new infrastructure takes time and money to build and ESG mandates make it tough for energy companies to justify large-scale fossil fuel projects.

Related: Bitcoin will surge in 2023 — but be careful what you wish for

Meanwhile, already strong demand will only increase once China emerges from its COVID-19 slowdown. Record growth in renewables and electric vehicles has helped. But there are limits. Renewables require hard-to-source elements such as lithium, cobalt, chromium and aluminum. Nuclear would ease the pressure, but new plants take years to bring online and garnering public support can be hard.

Reshoring of manufacturing

Supply chain shocks from the pandemic and Russia’s invasion of Ukraine have triggered an appetite in major economies to reshore production. While this could prove a long-term boon to domestic growth, reshoring takes investment, time and the availability of skilled labor.

In the short to medium-term, the reshoring of jobs from low-cost offshore locations will feed inflation in high-income countries as it pushes up wages for skilled workers and cuts corporate profit margins.

Transition to commodities-driven economies

The same disruptions that triggered the reshoring trend have led countries to seek safer — and greener — raw materials supply chains either within their borders or those of allies.

In recent years, the mining of crucial rare earth has been outsourced to countries with abundant cheap labor and lax tax regulations. As these processes move to high-tax and high-wage jurisdictions, the sourcing of raw materials will need to be reenvisioned. In some countries, this will lead to a rise in exploration investment. In those unable to source commodities at home, it may result in shifting trade alliances.

We can expect such alliances to mirror the geopolitical shift from a unipolar world order to a multipolar one (more on that below). Many countries in the Asia Pacific region, for instance, will become more likely to prioritize China’s agenda over that of the United States, with implications for U.S. access to commodities now sourced from Asia.

Persistent inflation

Given these pressures, inflation is unlikely to slow anytime soon. This poses a huge challenge for central banks and their favored tool for controlling prices: interest rates. Higher borrowing costs will have limited power now we have entered an era of secular inflation, with supply/demand imbalances resulting from the unraveling of globalization.

12-month percentage change in the Consumer Price Index (CPI), 2002-2022. Source: Bureau of Labor Statistics

Past inflationary cycles have ended when prices rose to a point of unaffordability, triggering a collapse in demand (demand destruction). This process is straightforward when it comes to discretionary purchases but problematic when necessities such as energy and food are involved. Since consumers and businesses have no alternative but to pay the higher costs, there is limited scope to ease upward pressure, particularly with many governments subsidizing consumer purchases of these staples.

Accelerating decentralization of key institutions and systems

This fundamental shift is being driven by two factors. First, a realignment in the geopolitical world order was touched off by broken supply chains, tight monetary policy, and conflict. Second, a global erosion of trust in institutions caused by a chaotic response to COVID-19, economic woes and rampant misinformation.

The first point is key: Countries that once looked to the United States as an opinion leader and enforcer of the order are questioning this alignment and filling the gap with regional relationships.

Meanwhile, mistrust in institutions is surging. A Pew Research Center survey found that Americans are increasingly suspicious of banks, Congress, big business and healthcare systems — even against one another. Escalating protests in the Netherlands, France, Germany and Canada, among others, make clear this is a global phenomenon.

Related: Get ready for a swarm of incompetent IRS agents in 2023

Such disaffection has also prompted the rise in far-right populist candidates, most recently in Italy with the election of Georgia Meloni.

It has likewise provoked growing interest in alternative ways to access services. Homeschooling spiked during the pandemic. Then there’s Web3, forged to provide an alternative to traditional systems. Take the work in the Bitcoin (BTC) community on the Beef Initiative, which seeks to connect consumers to local ranchers.

Historically, periods of extreme centralization are followed by waves of decentralization. Think of the disintegration of the Roman Empire into local fiefdoms, the back-to-back revolutions in the 18th and early 19th century and the rise of antitrust laws across the West in the 20th. All saw the fragmentation of monolithic structures into component parts. Then the slow process of centralization began anew.

Today’s transition is being accelerated by revolutionary technologies. And while the process isn’t new, it is disruptive — for markets as well as society. Markets, after all, thrive on the ability to calculate outcomes. When the very foundation of consumer behavior is undergoing a phase shift, this is increasingly hard to do.

Taken together, all these trends point to a period where only the careful and opportunistic investor will come out ahead. So fasten your seatbelts and get ready for the ride.

Joseph Bradley is the head of business development at Heirloom, a software-as-a-service startup. He started in the cryptocurrency industry in 2014 as an independent researcher before going to work at Gem (which was later acquired by Blockdaemon) and subsequently moving to the hedge fund industry. He received his master’s degree from the University of Southern California with a focus in portfolio construction/alternative asset management.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

What is the economic impact of cryptocurrencies?

Cryptocurrencies spur financial inclusion, protect against inflation and enhance the global economy despite the recession.

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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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.

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.

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 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 compared with those who experienced less than 50% inflation over the same period.

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.

Crypto will become an inflation hedge — just not yet

Crypto can act as protection against inflation, but not until it establishes its fundamentals and achieves mass adoption.

In theory, Bitcoin (BTC) should serve as a hedge against inflation. It’s easy to access, its supply is predictable, and central banks cannot arbitrarily manipulate it.

However, investors aren’t treating it that way. Instead, the cryptocurrency market is mirroring the stock market. Why is that? Let’s dive into what prevents cryptocurrencies from acting as a hedge against inflation, and what needs to happen to make them a hedge in the future.

Crypto could be a hedge, but it comes with inconveniences

Cryptocurrencies present a unique solution, given their lack of a central governing bank. You can’t lose trust in something that doesn’t exist. Its supply is finite, so it naturally appreciates in value. People using a blockchain with proof-of-stake protocols can access their funds at any time, while continuously earning staking rewards on their current balance. This means that the actual value of annual percentage yield is tied to the economic activity on the chain via its treasury and staking reward distribution mechanics. Those properties seem to address the cause of inflation in the traditional monetary systems — but some roadblocks remain.

Related: Inflation got you down? 5 ways to accumulate crypto with little to no cost

For starters, let’s examine the reasons why people invest in and hold cryptocurrencies. The majority of cryptocurrency holders see the future potential of those technologies, meaning some of their value is not currently present. They are speculative investments. Decentralization has been achieved by Bitcoin, but its exuberantly high energy costs remain unaddressed, and the majority of mining forces are still aggregated into a dozen mining pools. Ethereum has similar issues with energy consumption and mining pool centralization. Ethereum also has a security problem — more than $1.2 billion has already been stolen on its blockchain this year.

There’s also the issue of decentralized exchanges, or DEXs, which are currently not as fit for use as centralized exchanges. The DEX with the highest transaction volume, Uniswap, offers inefficient pricing compared with a centralized exchange. A simple trade of $1 million in Tether (USDT) for USD Coin (USDC) would cost over $30,000 more in fees and slippage than when executed on a centralized exchange.

These are technical problems that have solutions

Granted, these issues are being addressed. Several third-generation blockchains are tackling energy consumption and decentralization head-on. Privacy is improving. Crypto holders are beginning to accept that their wallets will always be fully traceable, which will prove enticing to new users who have previously been hesitant over blockchain’s hypertransparency. Projects seeking to merge traditional finance’s mathematical rigor with the native attributes of cryptocurrency are tackling the problem of DEX inefficiency.

Related: Ronin hackers transferred stolen funds from ETH to BTC and used sanctioned mixers

Mass adoption and integration need to happen before crypto can act as a bulwark against inflation. Crypto has characteristics of future value in an ecosystem that is currently struggling to establish its fundamentals. The crypto economy is still waiting for applications that will take full advantage of decentralization without sacrificing the quality and experience, which is especially important for widespread adoption. A payment system where each transaction costs $5 and the exchanged value is regularly lost will remain unfeasible.

Until the top cryptocurrencies can be used efficiently for real-world payments and decentralized applications provide a similar level of utility as centralized systems, crypto will continue to be treated as a growth stock.

Inflation is caused by a lack of trust — something crypto still needs

Inflation isn’t caused by just printing more money, which is to say that the presence of an asset doesn’t automatically cause its value to go down. Between September 2008 and November 2008, the number of billions of U.S. dollars in circulation tripled, yet inflation went down.

Inflation has much more to do with public distrust of the central monetary system. This lack of confidence — combined with corporate price gouging, the upheaval caused by pandemic relief packages and significant supply chain disruptions (accelerated, in part, by the war in Ukraine) — has landed us in the current crisis. The big money-print of 2021 didn’t cause inflation, but it magnified it.

Related: Has US inflation peaked? 5 things to know

In terms of presence, the supply of funds alone is not an overly significant issue for a store-of-value currency. What is stored is not necessarily part of the circulating supply. Gold, for example, exists in large volumes in the form of jewelry, bullion and so on, but in much smaller volumes on the commodity market. A market that took into account all the mined gold on earth would have a totally different price. Because this jewelry and bullion are not traded on the market at all, they do not affect the supply-and-demand curve. The same applies to currency.

Inflation is the result of a loss of trust that an asset is able to store its value over a long period of time. Most goods in this world are finite, so every party aware of the raised supply but unsure of the monetary policy will automatically factor it into their prices. Inflation becomes a self-fulfilling prophecy.

Crypto as an inflation hedge is possible, but not in the current climate

Cryptocurrencies fail as an inflation hedge during times of high volatility and market uncertainty. That said, they generally excel in steady growth environments where they easily outperform the market and where the relatively small market capitalization compared with fiat currencies plays in their favor as a growth stock. Current solutions to the problem of usability aren’t sustainable due to their speculation-based nature and low transaction volumes. The fall of financially unsound blockchains affects the entire ecosystem, which means that potential long-term solutions keep being derailed by scammers.

Related: Is Bitcoin really a hedge against inflation?

The more responsible and diligent the crypto community becomes, the more every sound protocol will benefit, and crypto will become a genuine hedge against inflation. Because cryptocurrencies currently follow growth stock patterns, they act as a good hedge against inflation during periods of stable growth but fail during times of financial crisis. As cryptocurrencies evolve, they’ll become an effective bulwark during these downturns too.

These days, it’s prudent to err on the side of caution when it comes to crypto investing during periods of market turmoil, and it would be unwise to use crypto as the only tool for shoring up investments against inflation. But this will shift as blockchain protocols continue to mature, and we’ll see an increase in the adoption and stability of cryptocurrencies as inflation hedges. The tools are already in place.

Jarek Hirniak is the founder and CEO of Generation Lambda and a certified quant with more than 20 years of software development experience. He spent six years working on trading systems at Citadel Securities and UBS, where he developed a series of novel trading systems and trading-related software platforms while leading multidisciplinary teams.

The opinions expressed are the author’s alone and do not necessarily reflect the views of Cointelegraph. This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice.