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Inflation refers to the decrease of a currency’s purchasing power due to increased prices in an economy. When there’s inflation, the same unit of currency you use to buy a couple of items will buy fewer items because the currency has lost value. Inflation is measured mainly against the Consumer Price Index (CPI).
As of November 2021, the CPI rose to 6.8%, the highest increase recorded in the last 39 years. This means a significant increase in the inflation rate, especially since the economy was opening up after the hit of the covid-19 pandemic.
Unfortunately, the inflation rate is expected to keep rising, and hence investors are looking for ways to hedge against it.
When traditional currencies, such as money, lose value, a hedge against inflation is an investment or an asset that preserves or grows its worth. Gold is one of the oldest assets used as a hedge. When there’s a rise in inflation, investors tend to purchase more gold, increasing gold demand. However, gold is scarce. As a result of the high demand and low supply, the value of gold rises, making it a good hedge.
That said, investors are looking for more hedges to diversify their portfolios. One of their options is cryptocurrencies, specifically bitcoin.
This article will look into the suitability of bitcoin as a hedge. If you would like to learn how to invest in a cryptocurrency super fund, you can read more here.
In the past five years, bitcoin’s value has increased by over 4700% compared to 113% for S&P 500 during the same time. This will make bitcoin one of the best financial assets to own right now. However, does that outrightly makes it a good inflation hedge?
This section will look at some factors that make bitcoin a possible inflation hedge.
As mentioned above, a hedge is an asset or investment used to protect against inflation because it either increases or maintains its value as the traditional currency loses its value. Assets that are used as hedges are known as hard assets.
To be considered a hard asset, it has to maintain its purchasing power or increase its value. It also has to meet the following characteristics:
Hard assets are typically limited in supply. This property helps to drive their demand high and hence increase their value. A good example is a gold.
This crypto is known for its scarcity compared to other fiat currencies when it comes to Bitcoin. In fact, there will only be 21 million Bitcoins that will exist in the world.
Therefore, this will help make it scarcer, increasing its demand and value.
This property enables hard assets to be durable in the sense that they’ll continue to gain demand over time. Bitcoin has so far shown impressive progress with the garnering of its demand. Its value in 2020 has since risen in 2021. Experts have predicted that the cryptocurrency will soon hit its USD$100,000 value mark. Therefore, the value demand is expected to continue increasing with time.
This is the ability of the complex asset to be accepted and valued by the market. Bitcoin has continuously outdone itself in this sector, seen from its remarkable rise in value in the past five years. Aside from that, in November 2021, Bitcoin reached an all-time value of USD$69,000, showing how much value this cryptocurrency has accumulated. Additionally, more and more corporations and institutions are warming up to the idea of bitcoin and adopting it. Bitcoin is also arguably one of the most popular cryptocurrencies due to its massive exposure in media. This shows how much this crypto has been accepted in the market despite people still learning about it.
Bitcoin ticks all the above characteristics of a hedge. Therefore, this is one of the factors driving the argument that bitcoin is a good inflation hedge.
As aforementioned, gold is one of the most common assets used as a hedge. However, Bitcoin has, in some instances, performed better than gold and other traditional hedges thanks to its high year-to-year returns. In 2021 Bitcoin rallied up over a 13% hedge compared to gold, which only garnered 4%.
Although this performance is, by all means, outstanding, note that it’s once in a while, which begs the question: Is Bitcoins on and off outstanding performance enough to make it a reliable inflation hedge? Find out in the next section.
Despite the excitement of hedging against bitcoin, there are numerous lingering issues and loopholes that could jeopardize Bitcoin’s usefulness as a hedge. It’s paramount that investors learn of both the possibilities and inadequacies of bitcoin as a hedge.
Here are some of the loopholes:
After its all-time high record of USD$69,000 in November 2021, Bitcoin lost about 23% of its value and decreased to USD$42,000. Recently, in January 2022, the cryptocurrency had a brief dip that saw its value go lower than USD$ 40,000.
Therefore, even though crypto has been hitting imposing record values, it has hit huge big dips equally. A decrease from USD$69,000 to below USD$40,000 in less than three months shows exceptionally high volatility.
Unfortunately, highly volatile assets aren’t suitable for hedging since, as mentioned before, a good hedge should be able to maintain its value, if not increase it.
The one thing that has made gold maintain its position as arguably one of the best hedges is that its value depends solely on its scarcity. The harder it’s to find something, the more valuable it becomes. Although there are many gold resources, not all have been extracted.
One of the reasons is that it’s very difficult to extract gold. As a result, this natural mineral has created value based on its scarcity.
Although Bitcoin is relatively scarce, and as discussed above, there will only be 21 million bitcoins in the world, its supply isn’t the only thing that dictates the value of Bitcoin. The value of bitcoin is subject to other forces like manipulation from bitcoin whales.
Bitcoin whales refer to individuals, organizations, or companies that hold very high amounts of bitcoins. A whale account can hold as high as 1000 Bitcoins. Due to their large holding, these whale accounts can dictate the value of bitcoin by either selling or buying it in large quantities. As a result, the value of Bitcoin can’t be relied upon by considering its scarcity only, making it a poor inflation hedge.
You have seen the possibility of bitcoin being a hedge and its loopholes on the same.
Therefore, to sum it up, although Bitcoin can be a good hedge, there are still some concerns that should be addressed to make it efficient.