Saturday, December 3, 2022
  • While cryptocurrency has been a volatile asset class, its prospects have mostly been immune to traditional market dynamics.
  • Cryptocurrency is expected to have a strong link with inflation, in the sense that as price pressures heat up, cryptos are likely to heat up even more.
  • If cryptocurrency was once a hedge against inflation and traditional market forces, that age might have passed.

An outlook into Africa’s crypto terrain

With an approximate population of 1.4 billion people, Africa is the world’s second-most populous continent. Africa boasts the world’s youngest population, with an average age of just 19.7, 10.7 years younger than the world average.

Around 60% of Africa’s population is under 25, making African youths the prospective key to the continent’s long-term prosperity. For a long time, African nations have suffered from poverty, low development, significant economic loss and crises due to recorded history, such as colonialism, civil conflicts, and rugged terrains.

Read: Africa: Redefining financial inclusion through decentralized

Nonetheless, Africa’s infrastructural underdevelopment has made it a significant hub for cryptocurrency growth, requiring only a smartphone and a network connection to access blockchain networks. In addition to fundamental crypto knowledge, which is still widely available on the internet.

Africa’s cryptocurrency industry has expanded by more than $100 billion in the previous year, making Africa a potential investment target for the crypto market in the following years. However, the cryptocurrency market, which exploded at the start of the Covid-19 outbreak, has plummeted from its all-time high.

Since November 2021, a crypto sell-off has reduced the worldwide market value of the nascent asset class from $3 trillion to just over $1 trillion in June 2022. African investors have not been spared the shock and worry caused by the recent crypto downturn.

DeFi creating solutions through blockchain technology. web3africa.news

DeFi creating solutions through blockchain technology.[Photo/business2community]

Understanding the latest crypto slump

While cryptocurrency has been a volatile asset class, its prospects have mostly been immune to traditional market dynamics. Network effects, speculation, and investor euphoria appear to have fueled the stock’s meteoric rise in price during the previous five years.

One of cryptocurrency’s key charms is its invulnerability to inflation, which has been advertised as a hedge against inflation in central bank currencies. According to JPMorgan Chase research from last October, institutional investors are putting money into Bitcoin since it acts as a “better inflation hedge than gold.”

“People used to believe that cryptocurrencies would not respond to typical financial market movements,” says Itay Goldstein, a finance and economics professor at the University of Pennsylvania’s Wharton Business School. “Recent trends indicate that they are inextricably linked.”

Most cryptocurrencies have a fixed supply, as per Coinbase. Bitcoin has a limited supply of only 21 million units. The quantity of Bitcoin mined is halved every four years. As a result, the scarcity of the currency should impact its value more than traditional economic considerations (and insulate it from inflationary pressure from more supply).

Traditional economic difficulties may be to blame for the recent decline in cryptocurrency valuations, suggest financial analysts. As per the latest data from the Federal Reserve, the recent decreases appear to be a result of growing inflation as well as expected interest rate hikes.

Read: Africa: The urgent need for regulations to protect crypto

The relationship between inflation and the latest crypto slump

Inflation refers to any loss in the buying power of money, which increases the average cost of goods and services in an economy. Inflation measures how much more costly a specific set of products and services has gotten over time (most commonly a year).

According to the International Monetary Fund (IMF), inflation is often a broad indicator that may offer a picture of a country’s cost of living. However, it may also be computed more precisely for specific items or services, like food.

Cryptocurrency is expected to have a strong link with inflation, in the sense that as price pressures heat up, cryptos are likely to heat up even more. This can assist in hedging against inflation by protecting investors’ wealth-seeking assets that can outperform inflationary increases.

However, the recent crypto sell-off looks to be closely tied to rising inflation rates. In Africa, inflation is anticipated to climb to 12.2 per cent, up from 11.7 per cent in November 2021. Unlike in previous years, Africa is not experiencing sluggish economic growth—demand is at an all-time high, but global supply systems cannot keep up.

Cryptocurrency has become a highly popular payment option, with some large merchants beginning to accept bitcoin and other similar currencies. The recent worldwide crypto slump reflects the uncertainty surrounding this inflationary period—and what governments will do.

The crypto sell-off is now part of a more significant sell-off of risky assets, which may be ascribed to governments’ new signals of beginning to raise interest rates to combat inflation. Cryptocurrencies are one of the non-fiat assets that profited from the low-interest-rate environment and are now experiencing the opposite effect.

Due to the excellent returns these digital currencies provide, investors have flocked to crypto rather than traditional and alternative assets such as gold. However, recent volatility in the cryptocurrency market has made many investors nervous. If a purchase is to outperform inflation, its performance must be constant.

Following last month’s bloodbath, the price of cryptocurrencies such as bitcoin plummeted by a wide margin, making it impossible to rely on cryptocurrencies while inflationary pressures are high. Experts also believe that the history of cryptocurrency is too recent to forecast its future performance.

Investment returns from an asset class take inflation into account, and the actual yield must be positive for investors to develop their wealth. However, tremendous volatility in cryptocurrency trading has rendered it a risky asset when inflation in Africa and many other nations has increased dramatically, raising worries of a recession.

Cryptocurrency has developed as a convenient means of making money. Its meteoric ascent in 2021 prompted many investors to resort to cryptocurrency. However, a drop in its value that began towards the end of 2021 and has continued into this year has raised new concerns about its stability.

This undermines one of the fundamental claims of cryptocurrency supporters: it functions as a cushion against inflation and central bank policies on fiat currencies such as the US dollar.

While cryptocurrency has been a volatile asset class, its prospects have mostly been immune to traditional market dynamics. web3africa.news

While cryptocurrency has been a volatile asset class, its prospects have mostly been immune to traditional market dynamics. [Photo/coindesk]

Can crypto survive the inflationary pressure?

Gold is a perfect example of an inflation hedge. Although its worth as a hedge is debatable, gold and other natural resources are physically limited; only so much can be extracted at any given moment. However, the term “digital gold” is deceptive, according to Eshwar Venugopal, a finance professor at the University of Central Florida, because most investors do not perceive it as such. “Many existing investors perceive it as a dangerous investment,” he continues, “and withdraw money when wider prices fall.”

More likely, the value of cryptocurrencies is linked to commercial use cases (such as Bitcoin for payments), network effects (such as more developers adopting Ethereum), and good old-fashioned enthusiasm. According to Venugopal, as more institutional investors have entered the market, crypto markets have grown more connected with traditional financial markets.

While institutional interest fuels crypto prices’ dramatic rise, it also binds them to traditional assets, increasing volatility. Venugopal claims that substantial financial institutions began “accumulating crypto reserves” in 2019 as a high-risk investment rather than a hedge.

When investors sell, they do not deal in a single asset class. Retail and institutional investors may sell off some assets to offset losses in others. There was a period when people would think about Bitcoin as a method to diversify from the market. However, if cryptocurrency was once a hedge against inflation and traditional market forces, that age might have passed.

Read: Crypto adoption and usage in Africa soars despite challenges

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