Key takeaways
- As inflation rises, people traditionally turn to assets such as gold, but Bitcoin is now emerging as a strong alternative for safeguarding wealth, particularly in regions with severe inflation.
- Bitcoin’s fixed supply of 21 million coins and its halving mechanism, which reduces the creation of new coins, make it a potentially valuable asset in inflationary times.
- In inflation-stricken regions like Latin America and Africa, Bitcoin isn’t just a speculative asset; it’s a crucial tool for preserving value and conducting transactions, bypassing unstable local currencies.
- Despite its wild price swings, Bitcoin has shown significant returns over time, outpacing traditional assets like gold and the Nasdaq, making it an increasingly popular choice for those seeking to hedge against inflation.
Inflation is a hot topic these days, with prices climbing higher and people looking for ways to protect their hard-earned money. While gold and stocks have long been considered safe bets, cryptocurrencies, especially Bitcoin (BTC), are now gaining attention as potential inflation hedges.
But can Bitcoin and its unique deflationary nature truly help guard against inflation, especially in areas where it’s out of control?
Let’s dive into this question and look at some real-world examples. Please note that Bitcoin is used as a proxy for the broader crypto ecosystem in this article.
Inflation and the need for a hedge
Inflation’s impact is familiar, with prices for everything from groceries to gas rising steadily. This erodes the value of money over time.
To counter this, investors often turn to assets that hold or increase in value during inflationary periods. Gold has traditionally been the top choice, but now Bitcoin is emerging as a strong contender.
What makes Bitcoin deflationary?
Bitcoin operates on a deflationary model, with a fixed supply limit of 21 million BTC. Every four years, the reward for mining new Bitcoin is reduced by half in a process called the halving.
This built-in scarcity is a key reason why Bitcoin is being considered as an inflation hedge. The idea is simple: If something is scarce and people want it, its value goes up.
Real-world examples: Bitcoin in Latin America and Africa
Bitcoin’s potential as an inflation hedge isn’t just theoretical. In regions like Latin America and Africa, where inflation has surged, people are increasingly turning to Bitcoin to safeguard their savings.
Venezuela is a prime example. The country has faced hyperinflation for years, with the local currency, the bolívar, losing nearly all its value. In response, many Venezuelans have started using Bitcoin to preserve their wealth. It’s not just individuals — businesses are also using BTC for transactions, completely bypassing the unstable local currency.
Argentina tells a similar story. With inflation consistently above 50% in recent years, many Argentinians have turned to Bitcoin to protect their wealth. In a country where capital controls restrict access to foreign currencies, Bitcoin provides a way to store value and transfer money across borders without the usual limitations.
Nigeria presents another compelling example. As inflation rises and the naira depreciates, Bitcoin has gained popularity as an alternative. Nigerians use Bitcoin for savings and remittances, which allows them to bypass the high fees and unfavorable exchange rates of traditional money transfer services.
In these countries, Bitcoin isn’t just a speculative investment — it’s a lifeline. When local currencies are in freefall, Bitcoin offers a way to protect wealth and conduct transactions in a more stable currency.
With the data from these countries, it can be argued that Bitcoin can be a robust hedge to hyper-inflationary environments in emerging markets. However, does that narrative hold ground in more developed economies?
Did you know? Inflation is commonly measured by indices such as the Consumer Price Index (CPI) and the Producer Price Index (PPI). The CPI tracks changes in the price level of a basket of consumer goods and services, while the PPI measures price changes from the perspective of producers.
How has Bitcoin performed compared to gold and the Nasdaq?
To understand if Bitcoin is a good hedge against inflation, let’s look at its performance over the past 15 years, especially compared to gold and the Nasdaq.
Bitcoin’s returns have been nothing short of a rollercoaster. There have been massive gains in some years and steep drops in others. This volatility is both its biggest attraction and its biggest risk.
Compared to the steadier returns of gold and the Nasdaq, Bitcoin’s performance is wild but potentially rewarding. On average, it has outperformed both gold and the Nasdaq, which is why it’s gaining popularity as a hedge.
When looking at the 10-year internal rate of return (IRR) for Bitcoin, gold and the Nasdaq, Bitcoin, despite its volatility, has achieved an impressive 64.5% IRR. Gold has managed a modest 7.1% IRR, while the Nasdaq has delivered 17.5%.
Did you know? The internal rate of return (IRR) is the discount rate at which an investment’s net present value (NPV) equals zero. NPV is the difference between the present value of cash inflows and outflows over time. For instance, when comparing assets like Bitcoin, gold and the Nasdaq, the IRR helps assess the most profitable over time by balancing the initial investment against the returns.
How does Bitcoin correlate with inflation and global liquidity?
Now, let’s tackle the heart of the matter: How does Bitcoin perform when inflation is on the rise?
In its early days, Bitcoin wasn’t really tied to inflation; its price was driven more by speculation and adoption rates. But things started to change during the COVID-19 pandemic. As governments around the world pumped money into their economies, fears of inflation began to surface.
Bitcoin’s price soared during this time, and more people began to view it as a potential hedge against inflation. The rise in Bitcoin’s price could also be attributed to the availability of liquidity in the global economy, which effectively pushed inflation higher.
However, 2022 was a wake-up call. Despite inflation reaching new heights globally, Bitcoin’s price fell sharply. So, is it really an inflation hedge? This price action from Bitcoin can be attributed to the liquidity crunch in the economy as the United States Federal Reserve started to hike rates at the fastest pace in history.
Some studies suggest Bitcoin has a low or even negative correlation with inflation, meaning it doesn’t always go up when inflation does. Others indicate that this correlation might be evolving, especially during periods of high inflation expectations.
Bitcoin’s correlation with global liquidity is closely tied to periods of quantitative easing (QE) and tightening (QT). During QE, central banks inject money into the economy, increasing liquidity and lowering interest rates. This environment often boosts Bitcoin’s price as investors seek higher returns in alternative assets.
Conversely, during QT, when central banks reduce liquidity and raise rates, Bitcoin often faces downward pressure as risk assets become less attractive. This dynamic shows Bitcoin’s sensitivity to global liquidity cycles driven by central bank policies.
Did you know? During the 2008 financial crisis, the US Federal Reserve’s QE program increased its balance sheet by over $3 trillion, marking one of the largest monetary interventions in history.
A couple of examples illustrate Bitcoin’s correlation with global liquidity:
- 2017–2018 bull run and QE: During this period, global liquidity surged due to years of QE following the 2008 financial crisis. With low interest rates and an abundant money supply, investors increasingly sought out riskier assets, including Bitcoin, which played a significant role in its dramatic rise in 2017.
- 2022 bear market and QT: In 2022, central banks, particularly the US Federal Reserve, began QT to combat inflation. This reduction in liquidity led to a sharp decline in Bitcoin’s price as risk assets became less attractive.
These examples show how Bitcoin’s value is influenced by global liquidity conditions driven by central bank policies.
Can Bitcoin and cryptocurrencies really protect against inflation?
So, can Bitcoin protect against inflation? The answer isn’t black and white. Bitcoin’s scarcity is a huge plus, and its independence from traditional financial systems is appealing. But its volatility is a serious concern. It can create wealth just as quickly as it can destroy it. However, most assets and asset classes are volatile in the early stages of their journey. As the asset grows in size and liquidity, volatility reduces over time.
If you’re considering using Bitcoin as a hedge, it’s important to go in with your eyes wide open. It might not behave like traditional hedges, and its price can be influenced by a range of factors that have nothing to do with inflation. For some, that unpredictability is part of the excitement; for others, it might be a dealbreaker.
In the end, whether Bitcoin can protect against inflation depends on your risk tolerance and your understanding of the market. It’s not a magic bullet, but in the right hands, it could be a powerful tool.
Written by Arunkumar Krishnakumar