We are witness to a highly turbulent period for wealth creation. We’re also experiencing this amid high inflation, rising interest rates and stagnant wages. In confronting this reality, one must ask, is crypto a viable solution to reviving flagging economies around the world and supporting widespread economic development, or is this just another scenario destined to fall into the same old cycles we’ve seen before? Is crypto truly a viable hedge against inflation, and is decentralized finance (DeFi) a practical supplement to help stabilize an imperfect financial system? Let’s explore some of the cycles and trends that may help reveal what the future of finance holds for the world.
Alternative financial avenues
The annual inflation rate in the U.S. has accelerated to a whopping 9.1% in June this year, the highest in 40 years. This is while food and gas prices continue to rise, and interest rates for homeowners now exceed 5% for a 30-year fixed rate mortgage. Stagflation, as Larry Summers has described it, is a perfect storm combining slowing GDP growth and rising inflation that creates a long-lasting effect. Seeing the U.S. economy shrink by 1.4% in the first quarter of 2022 may be a harbinger of this economic malaise. Combine this with the average APY on traditional savings accounts being an anemic 0.10%, a minimum wage that hasn’t been raised on a federal level in over a decade, and it becomes obvious we are in need of new ways to bolster our fiat-based economy and supplement our investments.
Our current economy is one that does not necessarily incentivize or reward traditional savings mechanisms in a way that adequately keeps up with inflation. This is one of the reasons DeFi has become popular. For many, DeFi represents a more immediate opportunity to grow their wealth in a way that can be more accessible than the traditional banking system. When one can earn orders of magnitude more in returns from investments in cryptocurrencies, investing in cryptocurrencies and digital assets becomes a very intriguing value proposition.
Economic cycles
In his book, “The Changing World Order,” hedge fund titan Ray Dalio describes economic cycles that repeat through history, vis-à-vis the changing power of nations. When a country becomes the dominating world power, its currency becomes the reserve currency for the rest of the world. During the reign of the British Empire, for example, pounds sterling once fueled the world economy. However, in 1944, the Bretton Woods Agreement made the U.S. dollar the de facto reserve currency of the world. Regardless of whoever happens to be in charge at the time, one constant remains: During periods of rising inflation, the easiest way for a government to deal with rising debt is to print more money; in other words, to inflate their way out.
Crypto as the next dominant cycle
There has been much talk of central bank digital currencies (CBDCs), yet when we have deflationary stablecoins already in the ecosystem, whose value can be pegged to collaterals, such as other cryptocurrencies or even traditional assets, what is the real benefit of a CBDC? The whole idea of a stablecoin is to offer a crypto asset whose value isn’t prone to extreme volatility. Most stablecoins achieve this stability by pegging their value to a fiat currency, such as the U.S. dollar or a basket of assets, which could include fiat and cryptocurrencies.
Moreover, most stablecoin projects also incentivize people to stay invested in the ecosystem by offering up derivative versions of assets they have locked in liquidity pools, allowing investors to engage in other DeFi protocols even while their main assets remain locked. They can earn generous interest and still use derivatives to take our loans, or earn yield in other places, compounding their initial investments.
DeFi is providing new avenues for economic growth while also giving power back to every individual, not just the superrich. By not being pegged to a nation-state currency and instead the broader development of the crypto-powered economy, DeFi protocols can offer generous incentives to save, earn and borrow with very little initial investment capital needed.
Macroeconomics may be pointing us toward crypto
During times of high inflation, alternative savings avenues and assets such as cryptocurrencies become more attractive by offering investments that are not as directly tied to a global reserve currency. As demand for these assets rises, they become more valuable and therein, more viable in other economies that are struggling around the world. We’ve seen examples of this in Turkey and Venezuela, where their national currencies continue to be unstable. This ultimately lends increased credibility to the idea of cryptocurrencies such as Bitcoin becoming a legitimate player on the world economic stage. Recognizing a currency that is not tied to a nation-state but based on an agreed-upon decentralized currency on an immutable, public blockchain is a big shift in the macroeconomic models of the world.
A decentralized system that allows individuals to transact directly with one another in a more efficient and transparent way is a monumental new step in our approach to creating more equitable and inclusive global economies. Taking all of this into account, it’s reasonable that we may consider crypto to be one of the most viable solutions currently available to us to answer the fundamental questions that inspired this article. While history may not repeat itself, it does rhyme — and crypto seems to be offering a different tune entirely.
DeFi is certainly offering people the opportunity to invest in deflationary assets with substantial return potentials not currently seen in the traditional finance space, and this helps create the potential for a new path to creating generational wealth. If historical cycles continue, crypto may just be the best hedge against the decreasing strength of fiat-based economies writ large. If talented developers continue to focus on removing barriers of entry, demystifying the DeFi experience and allowing anyone to interact with the crypto markets, we can continue to advance crypto forward and help broaden economic inclusion and development.