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Inflation has reared its head in 2022. While experts have warned of inflation since the pandemic began, February 2022 saw inflation rise to 7.9%, and many think it’s here to stay. Economists expect inflation to exceed 3% through the end of 2023, according to a survey by the National Association of Business Economics.
Higher inflation is already being felt. As investors experience the pinch of a devalued U.S. dollar, they’re seeking out investments that act as a hedge against inflation.
While many investors may gravitate toward traditional inflation hedges like gold or U.S. Treasury Bonds, Bitcoin is being touted as a viable alternative for the first time. But is Bitcoin a suitable inflation hedge?
The Short Version
- An inflation hedge is an investment thought to protect against inflation.
- Some of the more traditional hedges against inflation include gold and Treasury bonds. But some cypto enthusiasts think Bitcoin is also a good inflation hedge.
- Unfortunately, the historical evidence is murky and Bitcoin’s price has fallen in 2022 even while inflation has skyrocketed.
What Is an Inflation Hedge?
An inflation hedge is an investment that is supposed to protect the decreased purchasing power of a currency due to rising inflation. Hedging against inflation involves investing in an asset that will hold its value while currencies continue to be devalued.
For example, gold has traditionally been considered an inflationary hedge. This is because it often increases in value as purchasing power declines.
Many crypto fans have claimed that Bitcoin is a better inflation hedge than other popular choices like gold. But is it really?
In Theory, Bitcoin Should Protect Against Inflation
The theory that Bitcoin could be a good inflation hedge isn’t entirely unfounded. Bitcoin’s limited supply is a hallmark feature of assets that have historically protected against inflation.
There are nearly 19 million Bitcoin mined, but there will only ever be 21 million. Satoshi Nakamoto intentionally designed the currency to be a finite resource, mimicking the finite supply of gold.
This finite, digital gold model has caused many crypto experts to argue that Bitcoin is a good hedge against inflation. Crypto fans claim that as the supply of USD increases, the number of Bitcoin does not.
As a result, the value of Bitcoin should increase in relation to the U.S. dollar over time. The theory is simple enough, but the math doesn’t always work.
In Practice, Bitcoin Has Been an Unreliable Inflation Hedge
While the theory we outlined above might make Bitcoin seem like a good inflation hedge, it’s essential to consider the actual behavior of this cryptocurrency. In practice, Bitcoin doesn’t reliably track inflation.
If you look at the price of Bitcoin after it exploded in popularity in 2017, there is a dramatic level of volatility. Even excluding the past two years of activity due to the pandemic, you can see that Bitcoin crashed in both 2018 and 2019, when inflation was relatively stable.
When comparing Bitcoin’s performance to the M2 money supply or gold (a traditional inflation hedge), Bitcoin’s performance is far less stable than gold.
Bitcoin Is Untested Against Inflation – Until Now
So we know that Bitcoin was volatile during low, stable inflation. But the fact is that Bitcoin has never truly been tested against any real inflation (not like gold during the 1970s). So now that inflation is rising (and is projected to stay high), how has Bitcoin performed?
The answer is not great. In the spring of 2021, inflation started its march upward in earnest.
Bitcoin had many ups and downs throughout the year. It ultimately dropped 18% relative to the dollar, while other risk assets like the S&P 500 stock index grew 8%. Even traditional inflation hedges like gold faired better, rising 7%.
Three months into 2022, the trend continues to be clear. Bitcoin is down in 2022, moving in exactly the opposite direction of inflation.
So while Bitcoin may seem like a good hedge against inflation during several specific periods, overall it hasn’t been correlated with inflation in any meaningful way.
Bitcoin Is Vulnerable to Regulation
A quick analysis of Bitcoin’s recent performance indicates that it’s a volatile option for an inflation hedge. And there are still other factors to consider.
In particular, Bitcoin’s lack of regulation makes it a risky choice as an inflation hedge. While the lack of cryptocurrency regulation is seen by many as a benefit, the decentralization of Bitcoin relative to other fiat currencies makes it extremely vulnerable.
Anti-competitive laws or regulations, even well-meaning ones, could completely derail Bitcoin’s widespread adoption as a currency. These types of regulatory changes could tank the currency overnight.
Find out more >>> What Is the Future of Bitcoin and Crypto Regulation?
Bitcoin Is Vulnerable to Market Manipulation
While crypto is often touted as a way to decentralize finance and redistribute wealth from the 1%, the reality is far from this egalitarian dream. Large amounts of Bitcoin are concentrated with individual holders. These Bitcoin “whales” can manipulate prices by buying or selling their Bitcoin in large quantities. Enough to influence the cryptocurrency‘s price.
A forensic investigation conducted by the University of Texas and Ohio studied over 200 gigabytes of public transaction history between Bitcoin and Tether (a USD-backed cryptocurrency). It found that Bitcoin’s price boom in 2017 was entirely orchestrated by a single (and anonymous) market player. The market manipulation resulted in an all-time high price of $20,000.
This widespread manipulation points to Bitcoin’s price being largely dictated by speculation rather than the supply of coins as pro-inflation hedge theorists would have you believe.
Should You Buy Bitcoin to Hedge Against Inflation?
Bitcoin has become widely popular. Millions of retail investors are adding cryptocurrency to their portfolio. And the increase in cash and interest will keep the coin trading at new heights.
But when it comes to using Bitcoin as an inflation hedge, what does the (admittedly limited) data show?
Our verdict: Investors can’t presume any hard-fast correlation between inflation rates and Bitcoin’s price without more concrete trends.
Read more >>> Inflation Proof Investments
The Bottom Line
At this point, we consider crypto more akin to risky tech stocks than mature, stable inflation hedges like gold or U.S. Treasury bonds. But while we don’t think that Bitcoin is a reliable inflation hedge today, that’s not to say it won’t be one someday.
For that to happen, Bitcoin would need to become the “store of value” currency that theorists hope it will be. To achieve this status, Bitcoin will need to become more mainstream and significantly increase its market cap. Learn more about investing in Bitcoin here >>
