The year 2022 has been a whirlwind of high inflation for countries worldwide. Cryptocurrency only became mainstream in the last decade. Thus, the current inflationary period is the first time that both inflation and crypto transactions coincide.
One formula by financial organizations to reduce inflation is to increase interest rates. Thus, the rates charged on transactions like loans increase. Within the year, the U.S. Federal Reserve raised interest rates five times to counter the rising inflation. In the midst of these, the crypto industry was experiencing its own crash. With the constant hike in the cost of services and the volatile nature of the crypto market, the question on everyone’s mind is: How does Inflation and Taxes affect crypto?
In the following paragraphs, we will attempt to provide a bit of clarity on these questions.
How does Inflation affect crypto?
Inflation is simply explained as the rate of increase in prices over time, which leads to a decrease in purchasing power. The first thing to know is that crypto is not like fiat currency, so it should not respond to inflationary pressure like a standard currency. Secondly, many people view crypto as a store of value over time. Thus, when a currency loses value, they might want to preserve their spending by holding crypto.
However, cryptocurrencies are viewed as commodities and assets, and whatever regulatory framework affects a commodity, or an asset will automatically affect crypto.
In essence, what happens to crypto during an inflationary period is that supply increases. People are looking to protect their money in an asset class like crypto, and the supply of crypto increases as more of it is mined.
However, this is not always a hard and fast rule. There are stablecoins whose value is pegged with a fiat currency, for instance, the U.S. dollar and TetherUSD. If there is inflation of the fiat currency to which the crypto is pegged, the crypto (stablecoin) is also affected.
In addition, the falling state of crypto this year has shown that it is not really an inflation hedge. For instance, when the U.S. Fed announced the hike in interest rates in May, both the crypto market and stocks went down in value
How do Taxes affect crypto?
The direct implication of inflation is an increase in tax rates. Therefore, taxes also affect cryptocurrencies, especially in terms of trading. Since crypto is a commodity and an asset, it is subject to capital gains tax – tax on the realized value of the cryptocurrency.
With increased interest rates, crypto investors tend to pull away, causing the market to fall. In addition, taxing affects the crypto market when defaulting taxpayers seek to pay up deficits in a new tax season. In that period, there might be a drop in crypto price levels as investors sell off their holdings to pay their crypto tax liabilities.
Bottom line
Summarily, how inflation and taxes affect crypto is interwoven. Regardless, no evidence accurately depicts how much inflation and taxes impact crypto. However, with the trends we have seen since the start of 2022, can show investors patterns to predict what could happen. Lastly, the place of talking to a financial expert is still essential.
