Inflation affects people globally. As prices increase and the buying power of money decreases, people are in search of investments that can act as a hedge against inflation, thus maintaining the buying power of the capital invested. Question is, can bitcoin act as a hedge against inflation? is bitcoin the best hedge against inflation? In this article, we will take a look at what an inflation hedge is, how an inflation hedge works, as well bitcoin’s past performance and potential future as an inflation hedge.
Disclaimer: We want to emphasize that this is not financial advice. Cryptocurrencies operate in a volatile market, where values can drastically fluctuate in a blink of an eye. It is imperative to conduct thorough research and seek guidance from a qualified financial advisor before investing.
What Exactly is an Inflation Hedge?
An inflation hedge serves as an investment strategy strategically designed to shield against the erosion of a currency's purchasing prowess. This decline in buying potential stems from the ascending tide of prices, triggered by macroeconomic shifts or the ripple effects of inflation itself. Central to this concept is the notion of channeling resources into assets with the capacity to either uphold or amplify their value across a defined temporal span. Alternatively, the pursuit of an inflation hedge might manifest as an individual embracing a heightened stake in assets that, while susceptible to value reduction, exhibit a slower rate of decline compared to the currency's diminishing potency.
How Inflation Hedging Works
Inflation hedging plays a crucial role in safeguarding the value of investments by mitigating the adverse effects of rising prices. While some investments may initially appear lucrative, they can ultimately result in losses when accounting for inflation. Let's take a closer look at this scenario: suppose you invest in a stock or asset that yields a 4% return, but inflation stands at a staggering 7%. In this case, you actually end up losing 3% of your investment's value.
Certain assets have earned the reputation of being reliable inflation hedges due to their unique characteristics. Interestingly, these assets can also experience a self-fulfilling prophecy as individuals flock to acquire them. This surge in demand maintains their elevated values, although their inherent worth may be significantly lower.
Among the various inflationary hedges, gold stands out as one of the most widely embraced options. The price of gold in U.S. dollars is inherently volatile and subject to fluctuations. Consequently, when the dollar loses its value due to inflationary pressures, the price of gold tends to rise correspondingly. This increase in price acts as a protective shield for those who own gold, shielding them from the depreciating dollar. Essentially, the cost of an ounce of gold escalates as inflation intensifies, gradually eroding the value of the dollar. Consequently, investors are rewarded for their inflationary risk exposure as they receive additional dollars for each ounce of gold they possess.
A Real-World Example of Inflation Hedging
Inflation hedging is not limited to individuals; companies also employ this strategy to maintain affordable operating costs. A notable illustration of this approach is Delta Air Lines' acquisition of an oil refinery from ConocoPhillips in 2012. The rationale behind this move was to minimize the risk of surging jet fuel prices. Delta believed that by producing jet fuel internally, they could achieve cost savings compared to purchasing it from the market.
Through this strategic decision, Delta effectively created a direct hedge against the inflationary pressures that often plague the jet fuel industry. The company anticipated that by owning and operating the oil refinery, it could reduce its annual fuel expenses by a substantial $300 million. This bold step allowed Delta to insulate itself from market fluctuations and maintain greater control over their fuel supply, thereby ensuring a more stable financial performance in the face of volatile fuel prices.
The Limitations of Inflation Hedging
It's important to recognize that inflation hedging strategies, including the one adopted by Delta Air Lines, are not foolproof and can entail volatility and limitations. In the case of Delta's refinery acquisition, subsequent years have shown that the company has not been profitable in operating the refinery, thus reducing the effectiveness of their inflation hedge.
When considering the viability of commodities as an inflation hedge, the decision becomes complex and subject to various factors. Typically, arguments for or against investing in commodities as an inflation hedge revolve around a range of variables. These include global population growth, technological advancements, production fluctuations, political instability in emerging markets, Chinese economic growth, and global infrastructure investments. These dynamic factors are constantly evolving and directly impact the efficacy of inflation hedging strategies.
It's crucial for investors to carefully evaluate these variables and stay abreast of changes in order to effectively utilize commodities as an inflation hedge. This continuous monitoring allows for informed decision-making and an increased likelihood of achieving desired outcomes in hedging against rising inflation.
Why Bitcoin Can Be Considered as an Inflation Hedge
Bitcoin is often touted as a potential inflationary hedge due to its capped supply of 21 million coins, in contrast to the increasing supply of U.S. dollars over time. The concept is that if the supply of U.S. dollars expands, the value of Bitcoin should theoretically rise. In a scenario where the market cap of Bitcoin equals that of the U.S. dollar, a simple example suggests that the value of a single bitcoin would double as the supply of dollars doubles. However, it's important to note that this is a theoretical proposition.
In reality, the market is influenced by numerous factors that can complicate this simplistic relationship. Various elements, such as market sentiment, investor behavior, regulatory changes, technological developments, and geopolitical events, among others, can significantly impact the value of Bitcoin and other cryptocurrencies. These factors can challenge the direct correlation between currency supply and Bitcoin value.
Therefore, while some argue that Bitcoin could serve as an inflation hedge, it's crucial to approach this notion with caution and consider the broader market dynamics and potential risks at play. Thorough analysis and understanding of the cryptocurrency landscape, as well as its inherent volatility, are essential when considering Bitcoin as a potential inflationary hedge.
Bitcoin’s Performance as a Hedge So Far
When we reflect on the pre-draconian lockdowns era, it becomes clear that Bitcoin's role as an inflation hedge is questionable. In late 2017, Bitcoin experienced a surge in popularity, only to crash in 2018 and early 2019. It's worth noting that this fluctuation in Bitcoin's price was unrelated to inflationary factors. In that same period, while the M2 money supply witnessed a significant increase of 25.3%, the value of gold soared by an impressive 51.9%. Consequently, gold would have served as a more reliable and direct hedge against inflation compared to Bitcoin.
Examining Bitcoin's more recent performance in relation to actual inflation, it becomes apparent that it has not consistently acted as an effective hedge. Throughout the year, as inflation and inflation expectations continued to rise, Bitcoin's price actually decreased. This discrepancy casts doubt on Bitcoin's reliability as an inflation hedge.
It is important to consider these historical and present factors when evaluating Bitcoin's potential as a hedging instrument against inflation. While Bitcoin may exhibit periods of correlation or divergence from inflation, the inherent volatility and complexity of the cryptocurrency market warrant a cautious approach when solely relying on Bitcoin as a reliable inflation hedge.
The Future of Bitcoin as a Hedge Against Inflation
The future of Bitcoin as an inflation hedge is still a topic of debate, particularly as we approach the mining of the last Bitcoin from the limited supply of 21 million coins. While the final Bitcoin won't be mined for some time, it's intriguing to speculate on what might occur at that point. If the demand for Bitcoin remains the same or even increases after the last coin is mined, we could see Bitcoin entering a deflationary model. In this scenario, each Bitcoin would become increasingly valuable due to its constant scarcity and potentially rising demand.
However, the period leading up to the last Bitcoin being mined holds its own fascination. Bitcoin, along with other cryptocurrencies, is becoming more widely accepted as a store of value. This growing reputation as a store of value could lead to more price stability for certain cryptocurrencies, eliminating a key argument against Bitcoin as an inflation hedge. Additionally, as the price of Bitcoin stabilizes, more individuals may view it as a hedge against inflation, driving its value even higher over time. Such developments could position Bitcoin as a leading asset for hedging against inflation. Nonetheless, this is purely speculative, and only time will truly reveal the potential of Bitcoin, or even another cryptocurrency, as an effective inflation hedge.
It's important to note that cryptocurrencies offer something unique to investors—decentralization. While carrying gold coins can be a means of storing value during travel, it's impractical for larger amounts of wealth. Cryptocurrencies address this issue by enabling easy transferability of value, regardless of its amount. Furthermore, cryptocurrencies presently have a more accessible market than gold, as individuals can easily access exchange platforms.
However, it's crucial to acknowledge that we are currently in a transition phase. As the blockchain and cryptocurrency space continues to expand, a parallel economy with its own challenges will emerge. People will navigate between their physical reality and the virtual world they create, commonly referred to as the Metaverse. In the near future, at least one cryptocurrency is likely to serve as an inflation hedge in both worlds, playing a similar role in the virtual and real worlds. During this transitional stage, we can expect more stable cryptocurrency prices, as digital currencies will no longer solely act as stores of value that can be traded anytime. Instead, a clear distinction between digital currencies and digital commodities will manifest. We will transact with digital currencies primarily in the virtual world, and potentially in the real world, while storing value in digital and real-world commodities as the range of options expands. This progression will likely establish cryptocurrencies, or rather digital commodities, as viable hedges against inflation.
Bitcoin: Best Hedge Against Inflation?
Inflation is the increase in prices and the decrease in the purchasing power of a currency. The majority of investors look for investments that will, at the very least, combat inflation and act as a hedge against it. There is a lot of debate around whether or not bitcoin, or another cryptocurrency, can act as an inflationary hedge. Although the past performance of bitcoin and other cryptocurrencies is not ideal when trying to argue that they are suitable hedges against inflation. However, it can be said that past performance may not be indicative of future performance as we are currently in a transition stage. In this transition stage, people are slowly starting to explore cryptocurrency and all that the technology has to offer. This, combined with innovations in the blockchain space such as the Metaverse and NFTs, leads one to think that there is no telling what the future holds for cryptocurrency and blockchain technology. A cryptocurrency hedge against inflation may present itself, but it might not be bitcoin. Instead, it could be a digital commodity such as the gold or real-estate equivalent in the virtual world.