In the space of the past year, the value of the Bitcoin cryptocurrency has fallen from nearly $70,000 to less than $30,000, taking the entire crypto market with it.
Analysts suggest the currency, dubbed by some “digital gold,” will continue to see further declines as the broader market braces for a potential “crypto winter” of further price declines and stagnation.
Bitcoin has nonetheless been seen as a potential “inflation hedge,” a term used to describe commodities that can withstand the economic downturn caused by inflation.
Historically, gold has been considered one of the strongest hedges against inflation. Interestingly, however, in 2021 Bitcoin had outperformed both gold and the stock market for the third consecutive year.
During the COVID-19 pandemic, fearing that government spending would lead to inflation, institutional investors turned to Bitcoin as a hedge against it.
Discussion of its potential increased as Bitcoin reached highs of over $68,000 per coin in November 2021, with other major projects such as Ethereum, BNB, Polkadot, and Polygon also seeing huge increases in value.
The meteoric highs that Bitcoin and cryptocurrencies experienced in 2021 swept the global public consciousness. This led to a wave of institutional adoption, including El Salvador’s extraordinary decision to adopt Bitcoin as legal tender.
However, the situation is quite different in 2022, with El Salvador facing the possibility of default as Bitcoin’s value plummets.
There have been a number of factors that have induced more bearish sentiments towards Bitcoin, including the war in Ukraine, global economic instability, and the collapse of the stablecoin Terra.
One of the other biggest influences has been inflation, with rates soaring in the United States and the rest of the world.
The risks of investing in cryptocurrency are well documented; Bitcoin and to a greater extent the broader crypto market are still considered risky play.
Nonetheless, Bitcoin’s broad view often falls somewhere between invaluable and useless, a set of narratives that may not help educate someone looking to invest, especially as inflation continues to dominate the headlines. .
To this end, Newsweek reached out to several academics who study and teach topics surrounding cryptocurrency, bitcoin, and blockchains to ask the question: Is bitcoin a hedge against inflation?
Part of Bitcoin’s structure is that, unlike other forms of currency, it has a fixed supply of 21 million coins. Strong demand in this scenario would lead to higher prices, favoring its use as a hedge against inflation.
Gavin Brown, lecturer in financial technology at the University of Liverpool, said Newsweek that Bitcoin’s limited supply set it apart from fiat currencies (like the US dollar), which may be subject to quantitative easing as banks seek to combat global challenges such as COVID-19 and conflict Ukraine-Russia.
However, there are a number of other risks that could dampen Bitcoin’s appeal as an effective inflation hedge. “An existential threat to Bitcoin would be the well-documented potential 51% attack using a quantum computer, or similar,” Brown said.
“Notwithstanding this potential Black Swan event, the price of Bitcoin has always been very volatile, moving rapidly (up and down), with shifts in sentiment and regulatory approaches from thought leaders and nation states, respectively.”
Martin C. Schmalz, professor of finance and economics at Oxford University’s Saïd Business School, believes that Bitcoin is not an inflationary hedge, also noting how changes in interest rates seem correlated to the stability of Bitcoin, despite its fixed supply.
“I’ve predicted in the past on Twitter, and it seems to be consistent with the data, that a major reason for crypto crashing is rising interest rates. This happens when inflation is high. So by construction Bitcoin crashes when inflation is high,” Schmalz said.
“There’s even more evidence that it hasn’t been a risky asset class (including in recent days and weeks) than that it hasn’t been a good inflation hedge. .
“In fact, any comparison with currencies should, in my opinion, not be taken seriously, given the vast fluctuations in value (periods of dramatic inflation followed by periods of deflation in a short period of time).
“If you push an enthusiast on this question, you will soon notice that if they are able to recognize this fact, they will quickly refer to Bitcoin’s future potential to have currency-like properties.
“Of course, empirically, this can only be disproved when said future arrives. However, we can know today that in theory, it makes no sense for a currency whose supply cannot be adjusted to be a stable day. The demand for the currency moves, so its price will change unless the supply is also adjusted. The history of traditional currencies underscores this point.
Among the shocks in the cryptocurrency market was the collapse of the stablecoin Terra. Terra or UST was tied to the value of the US dollar. When hundreds of millions of dollars of UST were sold, it lost its $1 tie, leading to a chain of events that caused its value and that of the cryptocurrency LUNA (which exists on the same blockchain) to plummet. ).
Sarah Hammer, managing director of the Stevens Center for Innovation in Finance at the Wharton School, University of Pennsylvania, said the notion of whether Bitcoin can act as an inflation hedge could be affected by such tremors.
She said: “Stablecoins are different from Bitcoin. It is a cryptocurrency whose value is supposed to be pegged to an asset considered stable, such as the US dollar.
“There are many types of stablecoins, including reserve-backed stablecoins and algorithmic stablecoins. Reserve-backed stablecoins offer a one-to-one exchange for one US dollar.
“UST (Terra) is an algorithmic stablecoin, meaning it was backed by an algorithm on the blockchain that facilitates supply and demand changes between the stablecoin and a native cryptocurrency (which in the case of the ‘UST was Luna).
“When the Terra Anchor broke, Luna Foundation Guard traded 52,189 bitcoins in an effort to support the Anchor. This may have put direct downward pressure on the Bitcoin price. The resulting price volatility can determine whether Bitcoin would be suitable as an inflation hedge. .”
Many have speculated that more widespread adoption and regulation could broaden Bitcoin’s appeal.
Nevertheless, Andrew Urquhart, professor of finance and financial technology at the University of Reading, said Newsweek Bitcoin’s very nature as a decentralized currency could drive away some of its early supporters.
“Traditionally, Bitcoin was seen as an inflation hedge because the supply of Bitcoin is limited and known, while USD/GBP can be printed by central banks – and they’ve printed a lot during/since COVID ,” Urquhart said.
“For example, in March 2020, the amount of USD in circulation was $4.2 trillion and today it is around $9 trillion. However, empirical studies suggest that Bitcoin is not a hedge, but some have found that it is. Results differ due to their testing procedures. .
“One possible reason why bitcoin isn’t such a good hedge as it used to be is that the financial system is starting to accept bitcoin. Bitcoin futures/options/ETFs are all now available, major institutions are buying Bitcoin, so the correlation between Bitcoin and other traditional financial assets is increasing.
“Personally, I think Bitcoin could be a good inflation hedge. However, we are currently in a crypto recession and once we get out of it Bitcoin could be an even better hedge.”
Perhaps in part, Bitcoin’s relative infancy, coupled with its volatility and questions about its intrinsic value, has left some experts skeptical. The central question of whether it still has the potential to develop as a hedge with the same reputation as gold or real estate remains open.
Undoubtedly, Bitcoin’s value potential both financially and in broader payment systems has been gaining momentum around the world.
The tone of the conversation surrounding it has led to broad buy-in from retailers and institutions, many of whom are convinced of the returns it can bring. Should this momentum recover or even surpass its previous highs, the discussion of whether this is an effective inflation hedge could re-emerge with greater force.
For now, it seems, the jury is still out.
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Is Bitcoin A Hedge Against Inflation? Cryptocurrency Experts Weigh In
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