Could Cryptocurrencies Be The Solution For Hyperinflation?

crypto's impact on hyperinflation

Since Bitcoin burst onto the scene and brought cryptocurrencies into the collective consciousness, there have been more and more use cases discovered for this groundbreaking technology. One needs only to look at Ethereum and the variety of problems addressed with ERC20 tokens to realize that cryptocurrencies can do more than just hold value. From decentralized supercomputers (Golem) to the endless uses for smart contracts, cryptocurrencies continue to innovate. So, could cryptocurrencies be the solution for hyperinflation?

Some developers on the cutting edge of this technology are looking to use cryptocurrencies for just that – a means to stabilize global economies by combatting hyperinflation. If correctly implemented, this could have major impacts on international finance and could help to pave the way for further large scale adoption of crypto tech by nation-states. Before we examine the ways crypto can help mitigate this problem, let’s gain a better understanding of hyperinflation and then examine some of history’s most extreme and disastrous cases of this economic phenomenon.

What Is Hyperinflation?

Hyperinflation occurs when the devaluation of currency takes place suddenly, rapidly causing inflation to reach 50% in a month or 100% over three years. This devaluation of a currency means that the prices for goods and services shoot up and can lead to major problems for the impacted nation. In extreme cases, bank runs and civil unrest can quite literally tear apart the fabric of society.

While there have been several cases of hyperinflation in the last century—as we will see—it is a relatively recent development in the world of global economies. Specific conditions must arise in order to provide an environment where hyperinflation can take place, but one economic characteristic is absolutely required: fiat currency.

The Role Of Fiat Currency

Fiat currencies are used in monetary systems, hold no inherent value and are not backed by any physical commodity with intrinsic value. For the majority of human history, all forms of state-issued money either had intrinsic value (gold coins) or were backed by a valuable commodity (the US dollar and the gold standard). A fiat currency only maintains value through a collective agreement from all participants that it holds this value and through the power of supply and demand; if at some point the group’s confidence in the value falters, trouble is often around the corner.

This group consensus on value, while functional, can be downright disastrous in times of turmoil and economic uncertainty. This disconnect between a currency and a truly valuable commodity means that in times of economic emergency, governments can simply print more money as a means to stem the crisis. However, as we will see, this almost never has the desired effect, and in fact usually plunges the economy into deeper trouble, often leading to an out of control devaluation of a currency.

Before we look at crypto’s role in fighting hyperinflation, let's take a look at a couple of historical examples of hyperinflation and the conditions that led up to these crises.

Venezuela’s Hyperinflation

While the circumstances that lead to hyperinflation are varied and complex, here we will examine what led to Venezuela’s ongoing economic troubles.

By the year 2012, almost 90% of Venezuela’s export earnings came from the export of their massive oil reserves. The rise in oil prices leading up to this allowed for former president Hugo Chavez to implement a number of social welfare programs designed to improve the living standard for the poorest of the population, through wage subsidies, improved healthcare, and other programs. While these improvements in social infrastructure did help improve living conditions for some of the poorest in the country, they also increased government spending. Which is all well and good as long as the price of oil is strong.

Then in 2013, the global price of oil dropped, and with it, the demand for the bolivar (Venezuela’s currency) used to purchase barrels of oil from the Venezuelan government. President Maduro, who succeeded Chavez in March 2013, attempted to solve the problem by printing more money. While it is true that this occasionally can be used as a short term band-aid to slow down an economic crisis, in Venezuela’s case it did not work out that way.

Inflation Starts To Creep In

Printing more bolivars just added to the currency in circulation, pushing its value down even further. This, along with continually dropping oil prices and issues with petroleum production, pushed Venezuela deeper into economic turmoil. The growing uncertainty led Venezuelans to convert their local cash into more stable currencies, namely the US dollar. Eventually, the government imposed an “official” exchange rate between USD and bolivars in an attempt to limit this trend, however, since the official rate was less than the rate on the streets, Venezuelans continued to trade out their bolivars, deepening the problems.

In 2018, President Maduro made several attempts to stabilize the bolivar. First, he devalued the currency by 95%, the largest currency devaluation in modern history. He then officially tied the Venezuelan bolivar to the price of a barrel of oil as a means to transform the currency from fiat to a commodity-backed system. These quick fixes could not stem the tide of uncertainty, especially given the population’s lack of trust in the government given increasingly authoritarian and unscrupulous practices.

As of now, over 3 million Venezuelans have fled the country, looking for opportunity and stability. The economy is still in shambles, with little sign of bouncing back anytime soon, however, it is worth noting that cryptocurrencies have gained a foothold in Venezuela as a community-driven alternative to government-issued currencies.

Hyperinflation In Zimbabwe

For another historical example of the dramatic effects of hyperinflation on an economy, we look to the African nation of Zimbabwe. Originally a part of the British colony of Southern Rhodesia, the Republic of Zimbabwe was born on April 18, 1980 with its independence from the British crown. The causes of their economic woes can be traced back to the regime and policies of Robert Mugabe during the 1990s.

With his attempts at economic reform and restructuring, Mugabe’s strategies for solving Zimbabwe’s financial troubles actually did more harm than good. Another attempt at reorganizing society in Zimbabwe had disastrous results: Mugabe instituted a redistribution of the nation’s farms from white landowners to new, black Zimbabweans. Unfortunately, this attempt at reparations failed, as the new black owners had little experience cultivating crops. Between 1999 and 2008 Zimbabwe saw a dramatic drop in food production, leading to a corresponding drop in economic confidence.

Another factor leading up to the nation’s hyperinflation was Mugabe’s wars in the Congo. While paying inflated salaries to military and government officials, it is estimated that Mugabe was underreporting military spending to the International Monetary Fund by up $23 million USD per month. It is also worth noting the rampant, institutionalized corruption within Zimbabwe: The watchdog group Transparency International ranks Zimbabwe 160th out of 180 countries.

Economic Factors At Play

These events, along with other, widespread issues of political instability set a perfect stage for hyperinflation. As the Zimbabwe dollar dropped in value the Reserve Bank of Zimbabwe responded by printing more money, pushing the currency further into hyperinflation. During this time of economic uncertainty inflation rates rose steadily: 132.75% in 2004, 585.84% in 2005 and 6,6212.3% by 2007. 

While it is difficult to know the true numbers since the government of Zimbabwe stopped reporting their official statistics, it is estimated that inflation topped out at 89.7 sextillion percent, year-on-year in November 2008. This fantastic figure shows the extent of out of control inflation: at the height of the issue, a loaf of bread could cost $10,000,000,000 Zimbabwe dollars.

In 2009 Zimbabwe stopped printing Zimbabwe dollars and abandoned their national currency altogether. There are several ways to remedy rampant hyperinflation, but one of the most common is to switch to an outside currency, and this is just what Zimbabwe attempted to do. Out of convenience, the currency chosen was the US dollar, as that was the foreign money already commonly used in Zimbabwe. While this fairly effectively solved the crisis, hyperinflation is a tricky problem, with many outside forces involved, including the most difficult to affect, public confidence. Most recently Zimbabwe has begun to implement e-cash programs, although there are more reports coming out that hyperinflation is making a comeback in the African nation, so it seems this story is not over yet.

How Do Cryptocurrencies Deal With Hyperinflation?

Now that we have a more solid idea of what causes hyperinflation, the toll it can take on society and examined historical examples, let’s look at how cryptocurrencies fit into the picture.

As we have discussed, there are a number of variables that can lead to instances of hyperinflation, and cryptocurrencies, by their very nature, are not subject to these economic factors. This is because, unlike fiat currencies, cryptocurrencies have specific rules and functions that prevent the root causes of the problem written into their code: there is no way to alter this code to change the functionality of a token without a majority decision or creating an entirely different blockchain. This has huge implications for global economies.

Transparency

For most cryptocurrencies, this code is also public and transparent. This means that anyone with a computer can inspect the code, learn its rules, and even contribute to the creation of new coins. This transparency also helps to maintain public confidence in a currency: it is much easier to trust the stability of a currency when you can inspect the underlying code and participate in its continued growth.

Cryptocurrencies are also far less susceptible to human corruption. With a transparent code, it is practically impossible for an outside body to alter any of the blockchain’s characteristics for personal gain. Unscrupulous officials cannot simply print more money to line their pockets.  

Inherently Finite Supply

Another interesting way that cryptocurrencies are insusceptible to hyperinflation lies in their code. For almost every cryptocurrency there is a total amount to be created written in the protocols. There is no way to create more tokens once the total supply has been exhausted without a majority of users electing to create a new consensus protocol. This means that there is no way for any outside body or government to increase the total supply of tokens.

In fact, as time goes on for most cryptocurrencies like Bitcoin, inflation rates actually decrease over time, strengthening the value of the currency. The finitude of these currencies means that while there is no easy way to increase the total amount in the case of some emergency, they are also immune to overprinting, a main cause of hyperinflation.

Consistency

An additional way that cryptocurrencies can deal with hyperinflation is in their consistency. While it is true that the supply mechanism varies from one project to the next, every cryptocurrency has a regular, predictable means of creating new tokens. The production and circulation of tokens is not dependent on some backroom cabal of financial analysts speculating on the strength and direction of markets and deciding whether to print more money or not.  

Crypto’s Role In Fighting Hyperinflation

As we have seen, hyperinflation can be both a cause and symptom of social unrest and economic uncertainty and has the ability to severely disrupt a functioning society. While it is true that the crypto economy is growing, it is still a long way from being independent from other global economies. However, there is incredible potential for use cases across every industry and nation in the world, and the ability to address hyperinflation is just one example.

Whether as a means to initiate cheap, international money transfers or as a long term, stable source of wealth storage through commodity-linked stable coins, the potential for crypto technology to combat hyperinflation is growing all the time. As more and more governments and financial institutions learn about and become more accepting of cryptocurrencies the likelihood of their deployment as a response to the devastating economic phenomenon grows as well.   

 


 

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References

Golem. (2019). Computing Power. Shared. Retrieved from: https://golem.network/

Harare, C.K. (2019, October 12). It’s Official: Hyperinflation Has Returned to Zimbabwe. Retrieved from: https://www.fin24.com/Economy/Africa/its-official-hyperinflation-has-returned-to-zimbabwe-20191012

Lioudis, N. (2019, February 3). What Is The Gold Standard. Retrieved from: https://www.investopedia.com/ask/answers/09/gold-standard.asp

Sharma, R. (2019, June 25). Hyperinflation Produces Surge In Bitcoin Trading. Retrieved from: https://www.investopedia.com/news/hyperinflation-produces-surge-bitcoin-trading-venezuela/

Transparency International. (2018). Zimbabwe. Retrieved from: https://www.transparency.org/country/

ZWEUNHCR. (2018, November 18). Number of Refugees and Migrants From Venezuela Reaches 3 Million. Retrieved from: https://www.unhcr.org/news/press/2018/11/5be4192b4/number-refugees-migrants-venezuela-reaches-3-million.html

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