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What the Federal Reserve’s Inflation Plans Mean for Crypto

Published
September 28, 2020
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The Federal Reserve has faced a number of unprecedented challenges over the past couple of decades. After the 2008 financial crisis, the central bank struggled to bring inflation back to its target levels. A little over a decade later, the COVID-19 pandemic sent asset prices plunging once again and inflation levels back down to depressed levels.

Earlier this year, the central bank amended its monetary policy goals to adapt to these new environments and pave the way for a more robust and inclusive economic recovery.

Let’s take a look at the Federal Reserve’s revised mandate, what it means for crypto investors and how you can hedge your portfolio.

New Monetary Policies

The Federal Reserve’s mandate is to aim for maximum employment and price stability. In the past, the central bank defined price stability as two percent inflation as measured by the Personal Consumption Expenditures price index. The two percent goal was also symmetric, so there was equal concern with inflation falling above or below the target.

In August, the Fed adopted a new monetary policy framework that had been in development since last year. The new statement said that the central bank would “likely aim to achieve inflation moderately above two percent for some time” under a strategy that it called a “flexible form of inflation targeting”, known as Flexible Average Inflation Targeting.

Flexible Average Inflation Targeting, or FAIT, means that the Fed will target an average two percent rate of inflation over an extended period of time. As a result, the central bank will push inflation above the target rate for some time to make up for the time it has been below target, which is designed to create a long-term average of two percent.

The Fed also announced changes to the way it measures employment. Rather than looking exclusively at non-accelerated inflation rate of unemployment, or NAIRU, it will consider a wider range of statistics and base decisions on “assessments of the shortfalls of employment from its maximum level” and won’t raise interest rates just because unemployment is low.

What It Means for Crypto

Many investors are concerned that the combination of record fiscal spending and massive Federal Reserve balance sheets could lead to an increase in inflation. With the Fed’s new monetary policy, the central bank has essentially said that it would allow inflation to rise higher than two percent before taking action to curb it.

At the same time, equity valuations are setting fresh all-time highs despite the high level of unemployment stemming from the COVID-19 pandemic. Investors have a limited number of options when it comes to non-cash investments to hedge against the potential for rising inflation over the coming years.

Federal Reserve Crypto

The S&P 500’s Shiller PE Ratio on the Rise – Source: Multpl.com

Bitcoin is widely seen as a stable value store given its limited supply. If fiat currencies were to fall in value, due to the effects of inflation, Bitcoin could prove an easy way to store value and avoid the effects of inflation. It’s also cheaper to acquire and store than gold bullion, which is one of the only alternative ways to offset the effects of inflation.

While crypto assets have historically been on the fringe, institutional investors have been increasingly taking notice. According to a survey of nearly 800 institutional investors, more than one-third say that they currently own digital assets and 60% say that digital assets have a place in their investment portfolio—possibly as an inflation hedge or alternative asset.

Building Crypto into Your Portfolio

There are many different ways to build crypto assets into your portfolio as a hedge against inflation and investors should consider the pros and cons of each before making a decision.

The most common ways to invest include:

  • Cold Storage: Long-term investors can purchase Bitcoin or other crypto assets and hold them on cold storage devices.
  • Exchanges: Traders and investors can purchase crypto assets on exchanges that hold them in the same way that a brokerage account would hold them.
  • Securities: A growing number of exchange-traded funds and notes provide investors with a way to build exposure through securities rather than outright ownership.

If you trade crypto, you should be aware of the tax implications. Crypto transactions—including crypto to crypto transactions and crypto mining activities—are subject to capital gains taxes. The good news is that tax loss harvesting can help offset these taxes and crypto assets don’t have the same restrictions as equities (e.g. wash sale rules).

Federal Reserve Crypto

ZenLedger’s Easy to Use Interface – Source: ZenLedger

Traders and investors buying and selling crypto assets should consider using dedicated tax software to compute capital gains and losses and accurately report them to the IRS. ZenLedger connects with exchanges and wallets to automatically make these calculations and auto-populate tax forms while simultaneously helping you identify tax loss harvesting opportunities.

It’s also important to note that crypto assets may not be the right choice for some investors and it’s important to speak with a financial advisor before investing in them. For instance, crypto assets tend to be more volatile than conventional assets (including stocks or gold), which means that there’s an elevated risk with holding them in the short-term.

The Bottom Line

The Federal Reserve’s move to adopt a flexible average inflation targeting policy could open the door to higher than two percent inflation in the future. With conventional financial assets trading at lofty valuations, many investors are turning to crypto assets as a potential inflation hedge in the future amid record fiscal spending and Fed balance sheets.

If you’re buying and selling crypto, you may want to consider using dedicated crypto tax software to ensure that you’re accurately reporting to the IRS. ZenLedger simplifies the process and helps you identify tax loss harvesting opportunities to save on taxes.

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