Huobi Group CFO
Inflation is rearing its ugly head around the world, as economies exit from Covid-19 restrictions and consumer spending rises on the back of positive sentiment, pent-up demand and supply-side constraints. While consumers grapple with the rising cost of living, central banks have rolled out monetary tightening measures to tackle inflation.
On the other hand, many individuals choose to buy and hold a diverse portfolio of assets, in the hope that their returns will outpace inflation over the long term. With the growing popularity of digital assets, it’s no coincidence that some of the countries with the highest rates of crypto adoption also have some of the world’s highest inflation rates.
As a leading digital token, Bitcoin is seen as a defensive play during inflationary times as its supply is limited by design. Its inventor Satoshi Nakamoto capped the number of Bitcoin at 21 million to achieve token scarcity, and to protect its value.
But how has Bitcoin fared as an inflation hedge?
We’ve seen in the latest crypto market downturn that the token lost about 70% of its value from its November high, during a period of soaring inflation rates which prompted central banks to hike interest rates in quick succession. There is also evidence of Bitcoin’s increasing correlation with equities in recent years.
Does this mean that Bitcoin – or digital assets – is not as good a hedge against inflation as it’s made out to be?
Why the notion of an inflation hedge is flawed
For a more incisive and objective perspective, it helps to take a step back and re-assess the very notion of an inflation hedge. The Motley Fool argues that the traditional definition of an inflation hedge is flawed, as there are many factors that can impact an asset’s price in the near term. It cites developments such as the war in Ukraine and the U.S. rate hikes that can impact investor sentiment and result in severe price volatility – outcomes which are not linked in any way to an asset’s fundamentals.
Even gold, which has long been held by investors as the inflation hedge of choice, has had an inconsistent track record over the past few decades. If you bought gold in the early 1980s, you would have lost an average of 10% per year, compared with an average annual inflation rate of about 6.5%. This year, gold prices are up just 2.5%, far behind July’s annual inflation rate of 8.5%.
Apply a longer time horizon
Bitcoin was launched in 2009, so its track record of just 13 years during a period of historically low interest rates means more time is needed to demonstrate its ability to hedge against inflation. Nonetheless, Bitcoin’s trailing five-year returns reached 1,100% during a time when the CPI increased only 18.5%, suggesting that the token has served as an effective inflation hedge over this period.
Bitcoin may not be a safe haven asset
Crypto users who look to Bitcoin as a store of value during market turmoil or times of uncertainty may want to think twice. A study by South Korea’s Yongsei University, which compared how Bitcoin and gold responded to financial uncertainty shocks (such as stock market routs) and policy uncertainty shocks (measures imposed by governments), found evidence over the years that Bitcoin appreciates against inflation. However, the same study also found that Bitcoin’s prices fall significantly in response to financial uncertainty shocks, making it less suitable as a safe haven asset.
Indeed, with the market outlook still uncertain, we cannot rule out more volatility for Bitcoin (and other tokens) ahead. This means that whatever digital asset you buy or trade, you should always do your research instead of following the latest trends on a whim. Be aware of the significant price volatility of cryptocurrencies, and avoid overly aggressive trading strategies such as applying too much leverage.
As we have seen, there’s no asset that can consistently beat inflation, but you can certainly hedge against excessive risks when buying or trading cryptocurrencies by following the guidelines above. This will enable you to develop more prudent strategies and make more informed decisions, staying the course to participate in the future of finance.
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