Kassandra Learn: What is… Quantitative Easing (Part 2)
How Crypto can make a difference
In a nutshell…
Centralized banking is essential to the way that modern global finance works and integral to the way that most globalised economies function. This gives governments strong monetary controls and allows them to take action quickly when faced with economic issues, but also hands over a huge amount of trust and power to a small group of people. The decisions of these central authorities have, more often than not, resulted in unforeseen and severe economic recessions and depressions with the rest of the country footing the bill.
Quantitative Easing, an economic tool for priming the economy to get moving, involves increases to the money supply. Unfortunately, evidence has shown that increases in money without increases in production devalues a currency, with significant consequences in terms of increasing inflation.
Crypto currency, decentralized and “trustless”, can offer a solution for individual savers who want to escape the boom and bust (and bust and bust) of centralized economies like the US financial system.
We’ve talked about inflation in previous articles. Now we’re going to explore further how some crypto currencies can work to hedge against quantitative easing-induced inflation. In fact, as some research suggests, periods where an economy undergoes a surge of quantitative easing may correlate to an increase in the value of cryptocurrencies, even as fiat currencies like the US dollar, the Euro, the Pound sterling, and the Yen plunge in value.
As we’ve explored, many forms of crypto currency can be used as part of a diversified hedge or protection against inflation. There is one important way that many crypto coins differ from fiat currency: limited supply.
Take Bitcoin as an example of Bitcoin. Bitcoin, by its nature, is fixed in terms of how many can be mined and created. Bitcoin is essentially produced by solving harder and harder mathematical equations through the use of greater and greater volumes of computing power.
The idea, in a nutshell, is that as it gets harder and harder to produce Bitcoin at its upper levels of volume, the value will also increase. However, there is a finite limit on the amount of Bitcoin that can ever be produced. Unlike a fiat currency, no-one can conjure up more Bitcoin at the money printing press (or, as is more likely the case these days, with the stroke of a computer key). The amount that can be mined into the supply of Bitcoin will cap at 21,000,000.
This scarcity makes Bitcoin immune to the inflationary pressures that drive down the value of a fiat currency (or, in some but not all cases, a crypto with unlimited supply). This finite supply or a set of limiting controls can be found as an essential characteristic of many other crypto currencies.
In a central banking authority-backed currency, citizens have no say about actions like quantitative easing that drive down people’s purchasing power though no fault of their own. If you recall our previous article, no-one in Zimbabwe voted for astronomical rates of inflation. People very rarely vote to put themselves into poverty, suffering instead when politicians make choices for them. And yet that’s just what quantitative easing has done in the past, especially when these measures are focused on bailing out banks and big business. This devalues the money in your pocket while forgiving the debts of Wall Street gambles.
Crypto currencies, unlike fiat currency, require the consensus or votes of people who hold them to make changes (such as an increase to the overall supply). You can literally “vote with your dollar”. If you don’t want to vote to make yourself poorer, then you don’t have to. So if somebody has a vision for why more currency should be minted, they’d better make a very convincing case.
No government in the world offers this level of decentralized democratic action in terms of financial control.
Additionally, even though crypto currency is decentralized, crypto currencies’ “trustless” nature actually makes them more trustworthy in practice. This is because transactions and monetary control aren’t handled by a bank or a human but powered by thousands of different computers located all around the world.
Meanwhile fiat currencies can be affected when a country finds itself isolated from the global economy, sanctioned, or even just chooses to shut itself off and refuse its citizens the ability to officially change their money. These are wider consequences based on the non-economic actions of governments and the choices of politicians that can affect the money in the wallet of an ordinary person.
Transactions on Bitcoin’s network are bound by no such political whims. The rules here are precise and universal: all transactions all transactions must be verified by the network of records to be included in the currency’s ledger, or “blockchain”. Transactions are verified by a consensus from other computers on the network before payments are sent.
Other than these controls against fraud and double-spending, no secondary approval is necessary for a crypto currency to be transferred. The history of all transactions can be reviewed and examined but no higher authority has the power to tell you how, where, and when you can spend your money.
Another difference that gives crypto currency an advantage over fiat currency is the freedom for production. Crypto currency networks remove the need for a centralized financial system because they make everyone who holds them involved in the process of producing and sharing currency.
Anyone can generate their own currency at home (within the parameters set by that crypto community). Transactions don’t need any middlemen to make transfers possible. All payments are recorded forever.
A group of big banks operating on behalf of a central national bank or a government are no longer needed to make sure a currency works as a form of payment. This hands control back to the people who want to save and spend without fear of inflation or suffering the consequences of a central authority’s bad decisions.
In our final section, we’ll come to understand why this is significant for economies undergoing inflationary pressure and, specifically, why crypto currencies seem to flourish in the face of the large cash injections used for quantitative easing.
How has Quantitative Easing affected crypto currencies in the past?
One remarkable phenomenon is that during periods of intense quantitative easing, Bitcoin has seen some all-time record spikes in value.
The theory is that in the past, investment mechanisms (like gold, real estate, and stocks) were typically the preserve of the already wealthy. These have traditionally helped those with resources and connections to hedge their money against inflation.
So what’s changed? With guidance and a simple point of entry, everyone has the opportunity to benefit from crypto currency as a potential hedge. In periods of quantitative easing-induced inflation, the world’s biggest and most popular crypto currencies were specifically identified as alternative investment assets and ordinary and wealthy people alike flocked to them.
Take this quote from “The Impact of Quantitative Easing on Crpytocurrency”, published in the International Journal of Economics and Financial Issues:
Since 2020, the US government and Federal Reserve Board (FRB) issued a series of policies to stimulate the economy, including a policy called “unlimited quantitative easing”; on March 23, 2020, FRB announced that they would “buy assets in the amounts needed to support smooth market functioning and effective transmission of monetary policy.” In the same year, a remarkable bull market came for cryptocurrencies, the most popular one, Bitcoin (BTC) increased from $5000 in March 2020 to over $60000 in March 2021. Smaller cryptocurrencies, like Dogecoin (DOGE), also experienced huge increases and attracted much attention from the public. […]
We interpret that cryptocurrency’s role as a substitute for legal currency plays an important role in this bull market of cryptocurrencies. As formal studies proved, undesired monetary policy will raise the public’s concern over the legal currency. After the unlimited QE announcement, a huge amount of US Dollars flowed to the international market, to make the exchange rate stable, and also to fight the financial crisis, most of the countries in the world adopted a loose monetary policy.[…T]his QE process increased the concern over legal currencies, and the investors begin to look for other transaction options.
In short, the unwanted side effects of quantitative easing force investors and savers to find assets to hedge their money. People have therefore had more reason and interest to invest in Bitcoin and other crypto currencies. This increases awareness and cements crypto’s reputation as a viable hedge as part of a wider portfolio of assets.
Crypto technology decentralizes currencies, creating systems and currencies that do not need a central authority to operate. Crypto currencies can provide an alternative for spending, saving, and (most importantly for hedging) investing. The nature of many cryptocurrencies like Bitcoin means that their limited supply makes them immune to problems like inflation and stagflation that seem inherent to handing over monetary control to a central bank or government.
In fact, crypto currencies do this so well that many central banks in places like the US, the UK, the Eurozone, and China have started to investigate how crypto technology works and are trying to develop their own digital currencies (central bank digital currencies, or CBDCs). Crypto currency seems set to be the future of banking, it’s simply up to ordinary savers to decide how much control they want over their financial destiny.