As inflation mounts throughout the developed world and is above the range central banks are comfortable with (about 2-3% guidance yearly vs. 6%+ actual) and billions of people are suffering from their hard-earned savings being eroded, the question of whether bitcoin can be a hedge to inflation has never been more relevant. We’re going to explore whether or not bitcoin can beat inflation.
is pro-cyclical due to institutional investment, and has a short-term inverse relationship with inflation increases — it can’t be said to beat inflation in the short-term as a hedge
The first important point to make here is that bitcoin’s price has a fair amount of investment interest associated with it, especially from institutional investors, and including a couple of big players including a sovereign buyer (El Salvador). This does mean that bitcoin tends to be correlated with major stock indices, with some movement with more “bitcoin-specific” news, such as the recent collapse of FTX. This is because interest in bitcoin currently does include a huge speculative element.
Since news of inflation brings the idea that central banks are going to raise interest rate targeting even further up, for the moment, bitcoin has a short-term inverse correlation with inflation news. If inflation goes up, the price of bitcoin will tend to go down. Conversely, if inflation “slows”, for example a favorable reading of American consumer price index, then asset prices will rise including bitcoin — with a view on the Federal Reserve and other central banks slowing interest rate targeting increases.
2- Bitcoin’s anti-inflation is subtle, and the next major event is the halving
The way bitcoin money supply works is more subtle than people give the network credit for. By algorithmically determining the supply of bitcoin (and only allowing for the creation of 21 million), bitcoin follows a dramatically different path than the monetary policy performed by sovereign governments and serves as a stark counter-example to loose monetary policy.
Because sovereign governments that control their own currencies have the ability to inflate money supply, this is what has been happening in major developed economies. Setting a digital store of value that has a reducing monetary supply and scarcity in the network allows for disinflation — measured on a long enough time scale, bitcoin has achieved remarkable value creation and preservation.
Bitcoin has been through three halving cycles: at the very first, you could buy bitcoin for around $10 USD. After the second, you could buy it for around $500 USD — even the third halving has a price consistently below the current price trend, even though there have been wild surges and crashes in the bitcoin price within year-over-year variation.
It is in the halving cycles where bitcoin’s most prominent monetary control mechanism exists. Every 210,000 blocks that are mined triggers a decrease in the block reward for miners — an exact halving. Right now, the block reward for mining a bitcoin block is 6.25 bitcoin and in the next halving, it’ll be 3.125 bitcoin. Bitcoin has a path to being a totally scarce asset towards the late 2030s. With this algorithmic monetary supply and explicit limits on the issuance of new bitcoins, bitcoin is well-suited to combat inflationary trends caused by loose money supply in the long-term.
3- Unpair the speculative element with the underlying network activity and scarcity
It’s important to consider the speculation and price action separate from the underlying network activity and scarcity being generated by the bitcoin network.
One obvious point of contention when it comes to digital money supply is the ability for many cryptocurrencies to spawn, each purporting to represent some notion of digital value, from ownership of digital art, to governance tokens in a company’s future.
Yet, throughout the ICO craze, we’ve seen bitcoin persevere and stay strong — bitcoin dominance in markets has fluctuated, but the bottom has never gone out — and many of the tokens that competed for attention and mining before have slowly died on the wayside. By 2019, in fact, about half or more of ICO tokens were effectively dead.
Conversely, activity and usage on bitcoin has found a very favorable path. As an example, while nodes on the Lightning Network have recently taken a bit of a hit, the fact remains that while ICOs were dying left and right, the bitcoin protocol was able to push through fundamental changes that allowed for a “Layer-2” solution that promised fast/low transaction fees across the world for bitcoin holders. The number of nodes active on the Lightning Network has gone from around 2,000 in January 2019 to about 17,000 in December 2022. The network went from having a network capacity of around $2mn to $85mn.
With the United States and most developed economies (especially Europe) suffering a spate of inflation-related issues, from surging energy prices, to supply chain issues affecting popular goods, the idea of inflation has finally entered the “Western” media sphere. While the decrease of interest rate targeting to zero or negative levels after the 2008 financial crisis was regarded as having dulled inflation, this wasn’t quite true.
Now that inflation has rared itself in countries that aren’t associated as monetary “basketcases” (such as Turkey, Argentina or Venezuela), the issue has come up more frequently. Bitcoin is, when you unpack it, a good long-term hedge against monetary-led inflation, even if in the short-term, that can be lost in the surge and crash of price action.
Read More: Does Bitcoin Beat Inflation?