Since March 2020, central banks have created limitless new money, influencing the prices of stocks, real estate and Bitcoin, among other things. The price we have to pay for these asset price increases is record high inflation. This article analyzes whether Bitcoin is a hedge against inflation and establishes a direct correlation between money supply expansion and BTC price. Among other things, the following chart is discussed, in which a clear correlation and possible (predictive?) price explanation can be seen.
Is Bitcoin an Inflation Hedge?
An inflation hedge is an asset that maintains or increases its real purchasing power during periods of high inflation. Inflation can be viewed as consumer price inflation (CPI) or as a monetary phenomenon.
Your starting point is highly relevant for measuring whether Bitcoin has been able to maintain or increase its real purchase value. Possible start dates are March 31, 2020 (1), when the American Federal Reserve introduced a massive economic stimulus package and shortly before the American Congress introduced the CARES Act. Another option is April 2021 (2), when US CPI inflation officially exceeded the Fed’s 2% target. The third option is late 2021 (3), when supporters of “temporary inflation” have capitulated.
(1): Bitcoin has outperformed all other asset classes since March 2020. BTC has since returned 192% and would be a perfect inflation hedge.
(2) & (3): Bitcoin has corrected sharply since April and November 2021 (-67% over both time horizons). This data must be interpreted in the context that Bitcoin is a risk asset and is therefore corrected to the current negative market environment with rising interest rates more than others. Bitcoin is volatile, especially in the short term, as it is a young asset class and is influenced by macroeconomic factors. Despite this, BTC has not been able to maintain its purchasing power and since the cryptocurrency has only endured an inflationary cycle, this is the only comparison we have. So Bitcoin would not be a good inflation hedge.
Regardless of the price, Bitcoin is a way out of the state-created monetary inflation due to its limited supply of 21 million Bitcoins and thus a remedy against monetary inflation through the devaluation of currencies. At the same time, it is a safe haven from ever-increasing monetary policy interventions by central banks.
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What about gold?
Gold is traditionally referred to as an inflation hedge, how well has it performed since the three benchmarks? Gold has returned 7.7% since March 2020, and since April and November 2021 -4% and -4.4%, respectively. Of course, the recent correction plays a role. But even before this, the return was so low that the procurement and storage costs for gold were sometimes more than this return. So gold had what is called a “negative carry”.
What historically works best against inflation?
In general, risk assets beat inflation over the long term (decades) and generate positive real returns. This does not have to be the case in the short term, as can be seen in the example of Bitcoin.
Since commodities and energy make up a large portion of CPI inflation, these can also be tactically bought against increases in inflation. However, this requires good and careful timing and most investors burn their fingers as such timing is near impossible.
However, in Bitcoin’s brief history, it is clear that every portfolio should contain the crypto value as a means of diversification. BTC overcompensates for the additional risk with above-average returns. Since risk is often measured in terms of volatility, it is worth comparing Bitcoin’s Sharpe quotient, which adjusts the excess return for volatility and is used as a key figure by many financial managers, with other asset classes. Bitcoin beats gold, stocks, real estate and bonds, which is a clear argument for the cryptocurrency in every portfolio. Analyzes of different portfolio compositions also show that a small allocation to Bitcoin can have an above-average effect on diversification.
Conclusion Liquidity and Bitcoin: “Number go up”
Bitcoin price is quoted as BTC/USD. In this fraction there is a numerator (BTC) and denominator (USD) which can affect the price. So far, the counter has usually been the focus and thus the focus on the halving cycles. It is argued below that Bitcoin could be much more correlated to the denominator, or the amount of US dollars in the system, as Raoul Pal also argues.
The more dollars in the system tracking the same amount of bitcoin, the higher the bitcoin price. Since March 2020, mindless stimulus money and monetary easing by central banks around the world has led to rising liquidity in the system. This expansion of the money supply seems to have affected the BTC price very directly, as can be seen in the chart mentioned earlier. Ever since bitcoin has been traded, there has been a strong correlation between its price and the change in the US monetary base (US as the example of the most influential financial market). So Bitcoin is a measure of liquidity and currency depreciation.
(Research options for those interested: An inverse graph of the real 10-year Treasury yield should show a similar correlation.)
Based on the data, it is doubtful whether Bitcoin is an inflation hedge against consumer price inflation driven by consumer demand and corporate prices. But BTC is clearly an inflation hedge against monetary inflation, i.e. inflation driven by central banks. So to answer the question of whether Bitcoin is an inflation hedge, it depends on whether you are looking at consumer price inflation or asset inflation and what time horizon you are analyzing.
What Does All This Mean for Bitcoin Price? It has been established that Bitcoin is a hedge against monetary policy and it may be that the next BTC bull run will have to wait for the next change in monetary policy. How realistic is that?
The unsustainable levels of debt are forcing central banks to debase their currencies, which in turn penalizes people, companies and nations that hold USD, Euro or similar currencies. It is worth noting that the debts of one party are the assets of the next. As soon as the holder of these assets realizes that they have become devalued, they no longer want to hold them (e.g. US promissory notes) because their purchasing power is declining. So what happens when other parties sell their US IOUs? In that case, the US would either have to print more money to compensate for the selling (making the problem worse with more inflation) or not print money and slide into a debt crisis.
In the long term, the trend of fiat money supply is increasing, which could truly make Bitcoin a “number go up” technology.
About the author
Jonas Affolter is Managing Director of Affolter Consulting and works as a Bitcoin consultant in the DACH region. If you found this article educational, you are welcome to read this one Newsletter subscribe and share this article.
Disclaimer
This article is not intended as investment advice and is for informational purposes only. The views mentioned in this article were written by the author and may contain errors.
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