Is Bitcoin an Inflation Hedge?

[Xangle Digest]
By Moon Bit
Translated by elcreto

Summary

• Unlike the media narrative that Bitcoin is an inflation hedge, Bitcoin is more of a risk asset than an inflation hedge when compared side by side with the recent U.S. inflation rate.
• On the road ahead for Bitcoin to become 'digital gold' still lies an obstacle: it requires everyone to accept the proposition that Bitcoin is a store of value as well as a hedge against inflation.

Bitcoin & U.S. Inflation Rate

JP Morgan strongly advocated the proposition that Bitcoin is a new way forward amidst inflation, affirming that institutional investors see Bitcoin as a better inflation hedge than gold. Contrary to this narrative, as of Dec 2021, Bitcoin tumbled more than 30% from the peak in Nov. last year while the inflation rate announced by the U.S. Department of Labor stood at 7.0%, the highest since Jun 1982. So the result was the opposite of the argument that the limited supply of Bitcoin—as opposed to money printing—makes it scarce, rendering it an inflation hedge.

CPI has risen more than 8% since 2020 when the spread of COVID-19 started wreaking havoc. In contrast, after FOMC’s stronger-than-expected hawkish remarks in Nov and Dec 2021, preference for risky assets abated and the price of Bitcoin plummeted while the inflation accelerated.

2 Years On, the Trend Has Changed

In 2020 when the pandemic broke out, Bitcoin appeared to be replacing the role of gold, acting as an inflation hedge against the dollar. But since 2H 2021 when there was a 7% spike in inflation, Bitcoin’s year-on-year growth rate plunged from 700% to as low as 124% as risk preference cooled off, raising doubts about its potential to become an effective inflation hedge.

Can Bitcoin Be the New Gold?

Bitcoin needs to clear many hurdles to prove the narrative right. Bitcoin has often been compared to gold but unlike Bitcoin, gold has built confidence for a long time that its intrinsic value would never go on a wild ride. Before the end of the gold standard, gold was the currency and a store of value and has continued to act mainly as a store of value since the gold standard was abolished, growing 10 times larger than the U.S. M2 money supply.

Then, how about Bitcoin? How far has it come compared to gold? Last year, El Salvador’s president Nayib Bukele announced that the country formally adopted Bitcoin as legal tender, which took effect in Sep 2021. Focused on the function of Bitcoin as a means of payment, the country is building a Bitcoin payment system like PayPal, using it as ‘gold coins.’ But then, there are the others who view Bitcoin as a hedge against inflation and a store of value. Some of the most talked about examples are the remark of U.S. billionaire hedge fund investor Paul Tudor Jones, who once called Bitcoin “a store of wealth like gold" and JP Morgan’s note that read “Institutional investors appear to be returning to Bitcoin, perhaps seeing it as a better inflation hedge than gold.”

Apparently, Bitcoin currently is a currency that acts as a means of purchase and a gold coin as a store of value. It is being used for various purposes, such as to hedge inflation risk, to store value, or to invest in risky assets, without having their identity defined.

Barriers Ahead

The barrier Bitcoin has to overcome in becoming a true 'digital gold' is the prerequisite that everyone, including institutional investors and the general public, should recognize Bitcoin as a store of value. But, according to the “2021 Institutional Investor Digital Assets Study” released in Sep 2021—a survey conducted by Fidelity to track institutional investors’ behavior in the U.S., Europe, and Asia, institutional investors believed that price volatility (54%), lack of fundamentals (44%), market manipulation (43%), and regulatory classification (39%) were primary barriers to adopting cryptocurrencies. The study’s findings showed that institutional investors have worries about volatility and perceive cryptocurrencies as ‘risk assets,’ regardless of whether it hedges their exposure to inflation or diversifies their portfolio.

In order to turn this around, Bitcoin should either build confidence over a long period of time just like gold, or have a clear correlation with the inflation rate. We’ll stay on the lookout to see how Bitcoin gradually merges with the existing system, hurdles the barriers ahead, and comes of age to become a more mature asset than it is now.