Bitcoin Bolsters its Chops as an Inflation Hedge

With inflation on the tips of tongues of economists and investors, it would reason that many are now starting to scrutinize bitcoin, which has burnished its inflation-hedging credentials to determine how well it has fared or been faring.

On Wednesday, just as U.S. CPI data saw prices rise at their fastest rate since 1990, bitcoin rocketed to a record high?

And while correlation does not imply causation, for many investors, that bitcoin spiked on rising inflationary pressures is no coincidence and something which they have foreseen for a long time now – that the cryptocurrency makes for a great hedge against a rising prices.

The argument is elegant in its simplicity – with just 21 million bitcoin that will ever exist, bitcoin falls within that small class of assets which is alleged to be deflationary, algorithmically designed to have a limited supply not at risk of debasement or devaluation by a central bank or government.

But theory needs to be tested and the easiest way to do this is to plot U.S. prices against bitcoin, which is exactly what Bloomberg Opinion’s John Authers did to discover that bitcoin shows a deflation of roughly 99.996.

In other words, what cost one bitcoin a decade ago, would now cost 0.004 satoshis, the smallest unit of the cryptocurrency that now trades around US$64,000 at the time of writing.

Bitcoin’s inflation hedge credentials have been burnished for as long as it’s been around and was touted as its reason for being in the aftermath of the 2008 financial crisis.

That inflation-hedge narrative has gained traction in recent months as the prices for everything from food to energy, housing to holidays have advanced faster and proved sticker than economist forecasts.

Macro hedge fund investors like Paul Tudor Jones were one of the first on Wall Street to cotton on to bitcoin’s potential inflation-hedging properties, but more are joining the ranks.

MicroStrategy’s (+0.25%) Michael Saylor has long denounced the Fed’s relaxing of its inflation policy and has pushed his software firm to go all-in on bitcoin, making shares of the company a proxy for bitcoin performance, albeit an imperfect tracking tool.

Some economists at Bloomberg Economics estimate that at least half of bitcoin’s recent returns can be explained by its inflation hedging  credentials, with the rest stemming from market exuberance and momentum trading.

But calling an asset an inflation hedge does not automatically make it so.

Even gold has acted as a hedge against inflation when viewed from the lens of history and using data spread over centuries, for shorter durations however, an asset’s inflation credentials can be misleading at best, and misunderstood at worst.

To be sure, what matters more is correlation and right now, bitcoin appears to be moving up alongside prices.

Because there is no link between bitcoin’s supply and central bank policy, that lack of correlation makes it useful to act as ballast in a portfolio, regardless of its inflation-proofing credentials.

And although bitcoin’s price is very volatile, over the longer-term, inflation is not.

Perhaps more significantly, bitcoin has borne a strong correlation with stocks and other risk assets, which is really what investors should be keeping their eye on, inflation hedge or not.