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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 several 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 depressing 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. The Federal Reserve Board Chairman Jerome Powell recently said, "As the central bank of the United States, the Federal Reserve is charged with promoting monetary and financial stability and the safety and efficiency of the payment system".

    Let’s take a look at the revised mandate by the Federal Reserve, how there'll be a change in the Federal Reserve crypto investors' dynamics and how you can hedge your portfolio.

    Federal Reserve Crypto 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 is 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 the 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).

    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 of withholding 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.

    Federal Reserve Crypto FAQs

    1. What exactly is the Federal Reserve?

    The Federal Reserve System, often referred to as the Federal Reserve or simply "the Fed," is the central bank of the United States. It was created by Congress to provide the nation with a safer, more flexible, and more stable monetary and financial system.

    2. Does the Federal Reserve have a Cryptocurrency?

    Yes, the United States has taken a decisive step towards issuing its own central bank digital currency. The Federal Reserve crypto announcement states that it will release a research paper later this year that explores the move further.

    3. Will there be a digital dollar in the USA?

    A top Federal Reserve official said the United States is moving forward with a plan to develop a “central bank digital currency,” or CBDC.

    4. What is CBDC?

    Central bank digital currency (CBDC) is a generic term for the third version of currency that could use an electronic record or digital token to represent the digital form of a nation's currency.


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