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Inflation Is Soaring!
Why Isn’t Bitcoin?
Isn’t It Supposed to be a Hedge against Inflation?
Cryptocurrency enthusiasts often boast that a primary benefit of Bitcoin is that it hedges
inflation.
Many people think that because the supply of Bitcoin is artificially limited to around
21 million Bitcoins, its price will rise with inflation.
In March 2022, inflation was reported to be 7.9%, the highest it has been since 1982.
Inflation will probably climb even higher after Russia’s attack on Ukraine on February
24.
Yet, from November 2021 to February 2022, the price of Bitcoin dropped almost 50% while
inflation soared!
Why?
Indeed, Bitcoin itself periodically suffers severe inflation, as can be seen from this
chart.
An effective hedge will increase in price only because of inflation.
If other factors affect the price, then it may not hedge inflation.
The price of the hedge must increase with inflation.
The price swings of Bitcoin shown in this graph show no relation to the consumer price
index, or CPI.
There will be times when the price of Bitcoin will rise with inflation, but there will be
many times when it will decline, even as inflation rises.
Not even gold prices really track inflation effectively.
The reason is simple.
Just as with Bitcoin, other factors affect gold prices.
The price of Bitcoin depends more on factors other than inflation, such as the following.
The amount of hype encouraging people to buy Bitcoin.
The need for money to spend for consumption.
The anticipation of higher or lower prices for Bitcoin.
So if people expect lower prices in the future, they will sell to make a profit or avoid losses,
which will, naturally, lower Bitcoin prices.
Other cryptocurrencies, including those issued by governments, could also compete with Bitcoin.
A greater need for money will negatively affect Bitcoin prices.
Why?
The primary utility of money is being able to exchange it for goods and services.
While Bitcoin can be exchanged for goods and services in some cases, its disadvantages
as money is why it is rarely used as money.
Its main disadvantage is its volatility; its value changes by the hour.
Most businesses and other entities do not accept Bitcoin, so Bitcoin must be sold to
buy something.
Even entities that accept Bitcoin will probably sell it when they receive it to avoid the
risk of holding it.
Because Bitcoin is considered property under tax law, payment transactions would require
estimating the value of the goods or services received, which complicates payments.
Thus, a greater need for money will negatively affect Bitcoin prices.
Higher inflation is a systemic risk, meaning it could depress the value of many different
types of assets.
Higher inflation means people need more money to spend.
People get more money by selling their assets.
Other causes may also increase the need for money, like a pandemic.
At the start of the Covid-19 pandemic, all types of assets declined in price because
people needed money.
Bitcoin declined to less than $5000 at the start of the Covid-19 pandemic.
As a systemic risk, inflation affects everyone, so more people will sell Bitcoin when inflation
is high, thus lowering its price at the very time it is expected to be hedging against
inflation.
What is true of Bitcoin is also true of other cryptocurrencies.
But other cryptocurrencies have an additional risk, their monetary policy.
How is the amount of the cryptocurrency regulated?
People who control the amount of a cryptocurrency will be incentivized to create more, to enrich
themselves , which would inflate the cryptocurrency itself.
A large risk in holding cryptocurrencies is if the blockchains for the currency are no
longer maintained.
All cryptocurrencies depend on the blockchain to record transactions.
Therefore, all cryptocurrencies reside in a blockchain.
Cryptocurrency wallets only hold the keys to effect transactions in the blockchain.
If all the blockchains for a cryptocurrency are no longer maintained, then all of that
cryptocurrency disappears.
This is what happens in a so-called “rug pull”, where the creators of a cryptocurrency
sell their tokens, then disappear with the real money.
If you really want to hedge inflation, then by real estate.
Real estate is a better inflation hedge because it has other uses.
You can always live in a home or rent property.
Your home is a large factor in your quality of life, so not only buying a home is a good
hedge against inflation, but it directly improves your quality of life.
Because housing is the greatest expense for most people, any measure of inflation will
include housing costs.
Land is also a major economic input for the production of goods and services, so it will
always have value.
By contrast, Bitcoin serves only as a tradable asset; it has no other practical value.
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