March 7, 2023

Can Bitcoin Protect You From Inflation?

Inflation in the U.S. began to rise at an intensely rapid rate in May 2021, which is the point when the consumer price index dramatically increased by a whopping 5%. Investors were rattled by the circumstances, causing them to turn their attention toward inflation hedges, asset classes and investments that specifically protect against the loss associated with purchasing power.

Traditionally speaking, facets that have fulfilled that role include real estate, gold and even stocks in certain cases. That said, a more modern-day approach to defending against inflation is on the rise.

Those who support and take part in the exchange of cryptocurrency advocate for digital assets as a tool that acts as a shield, protecting people who use it from the impacts of inflation. On the other side, those who are skeptical of cryptocurrency are dismissive of cryptocurrency as a defensive strategy.

Even so, Bitcoin is by far the largest form of digital currency on the market, with many crypto advocates opting for Bitcoin over alternative cryptocurrency options. Taking it as a proxy for the crypto asset class, let’s examine the main arguments around Bitcoin as a form of inflation protection.

Bitcoin believers

Those in favor of Bitcoin emphasize the finite supply of Bitcoin as a form of cryptocurrency, which is an inherent feature of its existence. With a goal of obliterating inflation as a possibility, the original coders of Bitcoin contrived scarcity as a mechanism to counter inflation in the context of the cryptocurrency.

Bitcoins are capped at 21 million coins thanks to the cryptocurrency’s own algorithm. Moreover, while new Bitcoins are always being mined, the annual rate of mining is cut in half every four years. Consequently, as of April, a total of 19 million Bitcoins had been mined, leaving no more than 2 million coins available for mining in the future.

Once those remaining 2 million coins are uncovered, every possible Bitcoin in existence will have been mined. People who view themselves as proponents of Bitcoin challenge the scarcity of Bitcoin by pairing these coins with traditional, or fiat, currencies that are both printed and regulated by the world’s central banks.

In March 2020, back when COVID-19 became an inescapable aspect of our realities, $4.2 trillion was in circulation. Comparatively, $9 trillion is exchanged as of the present day, meaning central banks have the ability to print as much currency as they wish at will, which is in direct contrast with Bitcoin, seeing as the cryptocurrency cannot deviate from nor exceed the predetermined maximum supply, valued at 21 million coins.

As intense and impactful as inflation has recently become in the U.S. as well as in Europe, local currencies have resulted in even more volatile and unstable conditions. For instance, in countries such as Turkey, hyperinflation is rampant. Due to the volatility and unpredictability of the financial aspects of these economies, Bitcoin is particularly popular, seeing as it is regarded as an accessible instrument that can offset the dwindling purchasing power of local currencies.

Not so fast

Now, skeptics of Bitcoin retort that the evidence is still far too scant to rely on its accuracy, and even if they could trust the data in support of Bitcoin as a reliable defense against inflation, there are still a number of important statistics that contradict the claim. Aside from the question of longevity regarding whether digital assets can survive, let alone thrive, for now, disbelievers of Bitcoin’s abilities often consider the recent track record of its relationships, or correlations, with other inflation-related protectors.

The recent price of Bitcoin appears to be based more so on speculation than actual, legitimate inflation indicators. For instance, when the Federal Reserve raises interest rates, as it has been doing throughout 2022, Bitcoin appears to plummet. That said, in the past few months, Bitcoin has been behaving in ways that are akin to technology or momentum stocks, which typically react most forcefully to tighter financial conditions and higher rates.

But how has Bitcoin been stacking up lately against its potential rival: gold? Comparatively, gold has been performing better than Bitcoin ever since November, with the price of Bitcoin retreating by over 65% as of June.

Gold, which is often perceived as the perennial safe haven, has held its own over the same period. Now, as a whole, Bitcoin investors do not appear to treat the commodity as faithfully as gold, which they often regard as a long-term holding for a portion of a portfolio. Instead, Bitcoin speculators pull out swiftly when the crypto asset experiences a drop in price.

In October 2021, a JPMorgan Chase report caused a stir because it suggested that crypto might be a better inflation hedge than the ever-trustworthy gold. Time will tell, but the truth remains that Bitcoin is still a very young asset and its track record is so brief; both realities make it hard to draw reliable conclusions from current data alone.

One of the main advantages of cryptocurrencies has always been that they move along a trajectory that varies drastically and remains unrelated to the paths of stocks and other investments. However, if major financial organizations increase their Bitcoin holdings, the distinction between cryptocurrencies and traditional assets will fade. 

The value of Bitcoin in terms of safeguarding against inflation is a controversial topic, and cryptocurrencies continue to prove themselves to be risky. They may be right for you, but before you dive in, be sure to discuss the pros and the cons with your financial adviser.

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