What is inflation and how can you protect yourself from it with Bitcoin?

The thought of the value of our money decreasing is unpleasant, but unfortunately a reality we have to face in times of high inflation. Read on to learn what inflation is, how it decreases the value of our money, and how Bitcoin can serve as an inflation hedge.

Disclaimer: Economics is not an empirical science. This contribution is based on the intellectual framework of the Austrian school of economics, as well as a personal opinion. There are various monetary and economic theories that encompass different views, this paper represents one of them.

What is inflation? 

Inflation is the decline in purchasing power when prices for goods and services rise. Inflation is measured by the inflation rate.

However, this word has a long history. Originally referred to simply as the expansion of the money supply ("inflatio" - to inflate), over time inflation became established more for the designation of the price increase of goods and services. The inflation rate thus determines the change in the price level, or indirectly the value of money. It is calculated from prices of food, clothing, transportation and utilities, as well as cost of living and other goods and services.

For better clarity, we therefore distinguish in the following between quantity inflation (expansion of the money supply) and price inflation (increase in prices).

Over a period of several decades, the prices of goods (such as coffee or other foodstuffs) may double. However, this does not mean that the expansion of the money supply alone is to blame for the price increase of individual goods. 

Price inflation is often a consequence of bad economic decisions by politicians in combination with an expansion of the money supply by central banks. This is because the more money is printed (mostly to finance government spending), the more money comes into circulation, thus pushing down the value of money. Thus, inflation in the money supply often causes price inflation to rise as well. However, price inflation can also have other, mostly short-term, causes.

Price inflation is even factored into the calculations of central banks; the European Central Bank, for example, is aiming for an inflation rate of around 2%. According to the Austrian school of economics, this has no basis whatsoever. According to their representatives, such as Ludwig von Mises or Friedrich von Hayek, an economy works with any amount of money, as long as the units are divisible enough. A change in the money supply always entails unforeseen market shifts. 

It is difficult to escape price inflation, but you can hedge against it by acquiring assets that are scarce and in demand. Often, their value increases roughly in line with the rise in prices. This has been particularly evident in the real estate sector in recent years.  

How is price inflation measured? 

Inflation is not only measured in individual sectors, but also using various methods. These are geared to consumers, wholesale trade and the production of new goods. Each sector therefore has its own index with its own measurement methods.

Let's look at these areas now.

Consumer Price Index (CPI)

The consumer price index is probably the most popular and, for many consumers, the most important measure of price inflation. It measures the average price of consumer goods and services. 

For the calculation one uses certain articles of a shopping cart and measures their respective weighting. In doing so, one always uses the retail prices that are also offered to us consumers. 

In the past, however, there has been steadily growing criticism of this type of measurement, as certain items in the shopping basket, or their weighting, no longer reflect modern everyday life at all. Thus, many countries have also developed different approaches.

Wholesale Price Index or also Wholesale Price Index (WPI)

The wholesale price index measures and tracks changes in wholesale prices of products. It is less well known among consumers; it does not have a major impact on direct purchasing behavior. 

However, it helps from a macroeconomic perspective because it measures the behavior of large suppliers at the producer or intermediate input level.

Producer Price Index (PPI)

The producer price index is a collection of indexes that measure the average change in selling prices over time from the perspective of domestic producers of intermediate goods.

Even with this simple list of individual indices, one can see the main problem of inflation. No single index really covers the entire spectrum of price changes in an economy. 

Therefore, one uses different measurements or methods to make sure that one has a comparison between the results or sees a cause of the rising prices right away.

Calculation inflation

What does high price inflation mean for my money?

A high inflation rate means that your money is losing value. 

The longer the inflation rate rises, i.e. the longer money devalues, the worse it is for a country and its population. 

On the one hand, it shows weak purchasing power among the population, which causes the economy to falter. Most of the time, they can only buy a few new goods due to rising prices. 

On the other hand, too high price inflation is often a sign of poor monetary policy management in a country. While high rates of price inflation can also be generated in the short term by economic events, they are often the result of many years of money supply expansion, i.e. quantity inflation.

The basic idea of central banks is to separate monetary policy from government and to regulate the financial market and thus the economy in the form of key interest rate adjustments. 

However, the central bank becomes part of the problem when it itself gives in to the government's demand for money. This was seen in the last two years, when too much money flooded the market too quickly, although the previous years were also a contributing factor here.

At the moment, it is mainly the less affluent sections of our society that are suffering as a result. These are those who depend on an income and low inflation. When savings in the form of money are low and wages are just about enough, inflation eats away at reserves in no time at all, and higher prices ensure a lower standard of living. The upper classes do not have this problem, as they have larger savings or assets to fall back on.

So the more money there is in the currency and not in assets, or if there is even complete dependence on incoming wages, the harder one is hit by price inflation. One thing is clear: it is difficult to escape.

However, if you are in the advantageous position of having inflation protection, you have an option to fight back. 

An inflation hedge or inflation protection is an asset whose value cannot be easily influenced by government policy or central bank action. The best known examples of inflation hedges are real estate, gold and Bitcoin.

Why is bitcoin considered an inflation hedge?

Bitcoin as inflation protection

The phenomenon of price inflation does not come overnight, nor does it disappear so quickly. 

This is a point that most analysts in the media keep ignoring when they discuss the topic of Bitcoin as an inflation hedge. Most of the time they just look at the price since the last peak and then say that Bitcoin has failed as an inflation hedge. 

However, this is the wrong approach when looking at Bitcoin as an inflation hedge. 

The rise in inflation is largely the result of an excessively massive expansion of the money supply and, of course, of the current crises. If a larger money supply is distributed over the same number of goods, prices will rise.

If you apply this knowledge in comparison with Bitcoin in inflationary times, you will see how strong the digital currency can resist inflation

The best example of this is the price trend from April 2020 to October 2022. Even though Bitcoin has fallen from its peak during this time, you are still left with a 200% gain since the measurement began. 

This means that if you had held your money, or part of your money, in Bitcoin, you would have escaped inflation, so to speak. 

Why can you protect yourself against high inflation with Bitcoin? 

Bitcoin is seen as an inflation hedge because its total supply is limited. There will never be more than 21 million Bitcoin. This was deliberately designed to prevent demonetization by central authorities. 

Bitcoin inventor:in Satoshi Nakamoto had a limited money supply in mind from the beginning.

In addition, Bitcoin was developed as a deflationary money. Thanks to Bitcoin halving, the halving of block rewards for miners, the Bitcoin issuance rate halves every 4 years. 

The issuance schedule of new Bitcoin, is thus fixed until the year 2140, where the maximum amount of 21 million pieces is then reached..., 

Therefore, many Bitcoin investors hold the digital currency as a long-term hedge against price and volume inflation, as the value of the digital currency cannot be determined by governments or central banks, making it an exceptional inflation hedge.

Sign up for a Coinfinity account now and set up a Bitcoin savings plan today to protect your money from high inflation in the long run.

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What is the inflation rate of Bitcoin?

One can accurately calculate the bitcoin quantity inflation. This is the percentage of newly issued coins divided by the current stock. 

Thus, Bitcoin quantity inflation is currently 1.74% per year and is quite a bit lower compared to current money supply expansion rates in most countries. However, the rate of issuance of new Bitcoin continues to decline in the coming years as Bitcoin halves.

Is bitcoin now inflationary, deflationary or disinflationary?

Every 210,000 blocks, the so-called Bitcoin halving takes place, which reduces the mining rewards by half. As a result, Bitcoin volume inflation is also adjusted and continuously reduced. Thus, Bitcoin is generally traded as a disinflationary asset.