The Link Between Bitcoin and Inflation
It has been said that some investors have flocked to bitcoin in order to protect their wealth from the impact of rampant inflation. But what does that mean, exactly?
Bitcoin (BTC) is often touted as a hedge against inflation under the assumption that fiat money will eventually decrease in value due to central bank money printing. On the contrary, Bitcoin has a fixed supply of 21 million coins. The restricted upper limit gives Bitcoin an upper hand against inflation. But, is Bitcoin inflation proof?
The COVID-19 pandemic saw many countries printing more money to provide stimulus requirements for their respective citizens, thereby driving the value of money down. McKinsey Global reported that governments worldwide had provided $10 trillion by June 2020 to allay the economic havoc brought about by the worldwide crisis.
As the value of fiat money went down, the value of assets with a limited supply like stocks, real estate, shares and Bitcoin went up. Despite mass unemployment and economic unrest globally, the prices of these assets went up steadily. Bitcoin attracted traditional investors who saw the cryptocurrency’s potential as a hedge against inflation, driving a historic price run that saw the decentralized digital currency gain over 250%.
What is inflation, anyway?
Inflation is an economic term that refers to periods when prices rise over time. Often, that’s because a currency devalues – when one unit of the same currency buys you less stuff than it used to. If you watch a documentary from the ’80s and see someone selling a burger for 50 cents, while that same joint charges you 10 bucks – that’s inflation in action.
You might have realized the pinch of inflation when prices rise faster than your wages. You’re worse off if your $50,000 salary paycheck buys you 10% fewer goods and services than the year before. But if your employer boosts your salary to $55,000, you won’t have to change your spending habits and won’t feel the effects of inflation.
Economists think that a little bit of inflation is helpful to keep people buying, thereby stimulating the economy. But in times of economic crisis, like the coronavirus pandemic, inflation can get out of hand.
Economists disagree about the causes of the current bout of inflation – the worst in decades – which measures about 8.5% in the U.S. Some people point their fingers at the Federal Reserve for printing too much money, which in turn was used to stimulate the economy and handle the pandemic.
Others say that the Fed’s not squarely to blame – supply shortages caused by lockdowns were the main problem.
Bitcoin and inflation
While the economics around the Bitcoin market is complex, some cryptocurrencies, including Bitcoin, are designed to resist inflation or experience predictable and low inflation rates. And while Bitcoin is generally heralded as a hedge against inflation, recent economic developments have seen Bitcoin performing less as a pure hedge.
What role does Bitcoin play in inflation?
Largely driven by institutional investments, the cryptocurrency has become increasingly aligned with general market movements. This means that when the market goes down, Bitcoin likely goes down as well.
Consequently, when news of inflation strikes, the Federal Reserve will likely enact a dual mandate. Policy interest rates will go up, and there will be monetary tightening. As a result, assets (including crypto like Bitcoin) will see a price decline.
The argument against bitcoin being an inflation-resistant asset
While the U.S. dollar has fallen, bitcoin has far outpaced its value, rewarding early investors. But the cryptocurrency is highly volatile: Talk to recent investors who lost money when bitcoin cratered, and they might tell you that their investment has not outpaced inflation in the short term.
In the past few years, bitcoin has tracked the U.S. stock market, which performs well when the economy is stimulated and stutters when spending decreases – like in times of high inflation. When inflation reached 40-year highs in December 2021, bitcoin fell. The question of whether bitcoin is a long-term inflation hedge is difficult to answer without the benefit of hindsight.
However, not all cryptocurrencies work like bitcoin. Some cryptocurrencies are deflationary – meaning that the supply decreases over time, designed to increase the value of the coin over time (if the demand remained the same).