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Is Bitcoin Still An Inflation Hedge?
Bitcoin has plunged in value this year, weakening the argument often made by crypto enthusiasts that it can be an effective hedge against inflation.
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December 05, 2022
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FAQ
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Bitcoin has been touted as a hedge against inflation and a store of value versus fiat money by crypto investors and enthusiasts for almost a decade. Bitcoin's tokenomics have led many clever investors to assume it may be used as a hedge against the depreciation of other currencies.
There will only ever be 21 million bitcoins in circulation. All market players are aware of the Bitcoin issuance rate, and after all bitcoins have been mined, the Bitcoin network will be in a state of 0% inflation. This economic architecture, in the eyes of many investors and bitcoin supporters, is what sets bitcoin apart from other persistently inflationary cryptocurrencies and fiat currencies.
The impact of value manipulation
Fiat currencies are those whose worth is set by governments or central banks. The US Federal Reserve has set a 2% inflation goal for the US currency for over a decade. The decline in the dollar's value over time is another way to think about inflation. There is a long-term reduction in buying power when a currency experiences inflation.
On one side, there are the economists who think that inflationary currency creation would enhance the economy and business cycles.
However, many other schools of economics argue that a decline in the buying power of a country's primary currency is bad for the economy in the long run. Bitcoin, along with other cryptocurrencies, has been adopted and held by many as an alternative to fiat money because of this dispute and contrary viewpoint.
Evidence of bitcoin as an inflation hedge
There is no doubt that Bitcoin has surpassed the performance of traditional currencies over the last decade. But whereas many fiat currencies remained constant over the previous decade, bitcoin’s price did not.
Bitcoin has grown immensely popular throughout the globe, has been embraced and utilized in huge sections of the global economy, and has witnessed a very spectacular growth rate. In 2012, the price of a bitcoin was about $100, but by 2021, it had risen to approximately $70,000, more than a 7,000% increase in value.
The performance of bitcoin over the previous decade provided more proof of the asset being a hedge against fiat currency depreciation and bolstered its store of value investment thesis.
The inflation hedge story changes
In 2022, though, it will be a different story. Beginning in 2022, the U.S. Federal Reserve started to hike interest rates and remove liquidity from the market. Spurred by record high inflation, the U.S. Federal Reserve used these extraordinary steps in an attempt to battle inflation in the economy.
By hiking interest rates and lowering market liquidity, the Fed caused assets like stocks, bonds, real estate, and even cryptocurrencies to suffer enormous headwinds. Over 20% of U.S. equities are down so far this year, 30% of bonds are down, 15% of U.S. real estate is down, and 60% of cryptocurrency values are down (as of November 2022).
The "risk-off" climate is what many traders call the market in 2022.
Bonds reassert primacy
Investment in US treasuries is often regarded as the safest option available. Bonds with a guaranteed yield and principal protection are popular among investors because of their low risk and high return.
In response to the Federal Reserve's major rate hikes this year, risk-free rates on U.S. Treasury bonds are at their highest level in almost a decade. Many investors perceive this as a chance to invest in government bonds, and thus, they have started acquiring and investing in government bonds over other assets like stocks and crypto.
In reality, folks were so eager to buy these bonds, and the online traffic of people accessing the Treasury Direct website was so high, the website couldn’t manage the load and collapsed.
As the market changed from a "risk-on" climate, where bond rates were low enough that investors chose a more speculative asset allocation, to a "risk-off" situation, cryptocurrencies have lagged many other assets.
This underperformance has caused many crypto detractors to declare that the inflation hedge and store of value underlying bitcoin have been discredited. These people feel that cryptocurrencies are "risky" investments.
Specifically, when the risk-free rate in the economy is low and U.S. government bond rates are tiny, as they have been for much of the previous decade, investors will rush to assets like equities and cryptocurrencies, where the potential return is much larger than in bonds.
When the market is "risk off," market participants think investors will flock to treasuries over speculative assets like bitcoin.
Bitcoin’s future as a risk asset
While bitcoin is still extremely new compared with other asset classes, these marketplaces are helping users comprehend the primary investing theory behind cryptocurrencies. It is crucial to grasp all the complexities that go into global markets and investment allocations and know how to pivot when the market shifts.
There has never been a point in bitcoin’s history when the risk-free rate has been this high, and the final conclusion will be extremely advantageous for investment managers in the future. Whether or not Bitcoin and other cryptocurrencies are long-term inflation hedges and a store of wealth or merely "risk-on" speculative assets favoring investors in times when bond rates are unappealing is yet to be properly understood.
This year has been notably different than much of the past decade, and the market we are presently witnessing will be highly useful to advisers who seek to better comprehend this new and growing asset class.
Conclusion
Bitcoin's trailing five-year return of 1,100% at a period when the CPI grew just 18.5% shows that the world's leading cryptocurrency is truly an excellent inflation hedge. Despite its extraordinary volatility, people who acquired Bitcoin would have seen their buying power surge. If consumers could simply see farther down the road, they would find investing much less complicated. Many readers already know that the following month, quarter, or year may hold almost any event. It's futile to build a portfolio's structure on what could happen in such a short time since the future is really unpredictable.
FAQ
What is Bitcoin's status as an inflation hedge in the present day?
Given the constraints on the expansion of supply, the resulting price rise should be greater than inflation. So, while Bitcoin has not been an effective inflation hedge in the short term, the story changes when we look at it over a longer period of time.
Is Bitcoin inflation-proof?
Gold and crypto have been labeled "inflation-proof" investments—so far in 2022, neither looks to be a solid hedge. Gold and cryptocurrencies are sometimes thrown together as inflation-proof assets, but with prices growing at their quickest rate in decades, neither asset has done well under rising inflation in 2022.
Do rising prices affect Bitcoin?
Though not entirely immune to inflation, Bitcoin and other cryptocurrencies are less vulnerable to price increases than traditional currencies. For this reason, bitcoin has gained favor among those seeking a hedge against inflation.
That's all for today, see ya tomorrow! If you want more, be sure to follow our Twitter (@croxroadnews)
DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.
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