Over the past year, the value of the Bitcoin cryptocurrency has dropped from nearly $ 70,000 to less than $ 30,000, which has taken the entire cryptocurrency market with it.
Analysts suggest that the currency, dubbed some “digital gold”, will continue to see further declines as the broader market prepares for a potential “crypto winter” with further price declines and stagnation.
Bitcoin has nevertheless 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, by 2021, Bitcoin had surpassed both gold and the stock market for the third year in a row.
During the COVID-19 pandemic, fearing that public 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 share. coin in November 2021, where other major projects such as Ethereum, BNB, Polkadot and Polygon also experienced large increases in value.
The meteoric heights 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 a 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 sentiment towards Bitcoin, including the war in Ukraine, global economic instability and the collapse of stablecoin Terra.
One of the other biggest influences has been inflation, where rates have risen sharply in the United States and the rest of the world.
The risk of investing in cryptocurrency is well documented; Bitcoin and, to a greater extent, the broader crypto market are still considered risky games.
Nevertheless, Bitcoin’s broad vision often falls somewhere between invaluable and useless, a set of narratives that may not help educate anyone who wants to invest, especially as inflation continues to dominate the headlines. .
To this end, Newsweek reached out to several academics studying and teaching topics around cryptocurrency, bitcoin and blockchains to ask the question: Is bitcoin a hedge against inflation?
Part of Bitcoin’s structure is that, unlike other currencies, 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, a lecturer in financial technology at the University of Liverpool, said Newsweek that Bitcoin’s limited supply sets 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 the Ukraine-Russia conflict.
However, there are a number of other risks that could dampen Bitcoin’s appeal as an effective inflation hedger. “An existential threat to Bitcoin would be the well-documented 51% potential attack using a quantum computer or similar,” Brown said.
“Regardless of this potential Black Swan event, the price of Bitcoin has always been very volatile and moving fast (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, and also notes how changes in interest rates appear to be linked to Bitcoin’s stability, despite its firm tender.
“I have previously predicted on Twitter, and it seems consistent with the data, that a major cause of cryptocurrency is rising interest rates. This happens when inflation is high. So by construction, Bitcoin crashes when inflation is high,” said Schmalz.
“There is even more evidence that it has not been a risky asset class (including recent days and weeks) than there has not been good inflation hedging.
“In fact, any comparison with currencies, in my opinion, should not be taken seriously in view of the large fluctuations in value (periods of dramatic inflation followed by periods of deflation in the short term).
“If you push an enthusiast on this issue, you will quickly notice that if they are able to recognize this fact, they will quickly refer to the future potential of Bitcoin to have currency-like properties.
“Of course, empirically, this can only be disproved when the said future comes. But today we can know that in theory it makes no sense that a currency whose supply cannot be adjusted is a stable day. The demand for the currency moves so that its price will change unless 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 were sold in UST, it lost its $ 1 draw, leading to a chain of events that caused its value and the value of the cryptocurrency LUNA (found on the same blockchain) to fall. .
Sarah Hammer, executive director of the Stevens Center for Innovation in Finance at Wharton School, University of Pennsylvania, said the idea of whether Bitcoin could 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 linked to an asset that is considered stable, such as the US dollar.
“There are many types of stablecoins, including backup-supported stablecoins and algorithmic stablecoins. Reserve-backed stablecoins offer a one-to-one exchange for a US dollar.
“UST (Terra) is an algorithmic stablecoin, meaning it was supported by a blockchain algorithm that facilitates supply and demand changes between stablecoin and a native cryptocurrency (as in the case of ‘UST was Luna).
“When Terra Anchor broke, the Luna Foundation Guard traded 52,189 bitcoins in an attempt to support the anchor. This may have put a direct downward pressure on the Bitcoin price. The resulting price volatility may determine whether Bitcoin would be suitable as an inflation hedge. . “
Many have speculated that more widespread adoption and regulation could expand Bitcoin’s appeal.
Nevertheless, said Andrew Urquhart, professor of finance and financial technology at the University of Reading Newsweek The very nature of Bitcoin as a decentralized currency could drive away some of its early adherents.
“Traditionally, Bitcoin was seen as an inflation hedge because the supply of Bitcoin is limited and known, while the USD / GBP can be printed by central banks – and they have 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 that’s it. The results differ due to their test procedures.
“One possible reason bitcoin is not as good a hedge as it used to be is that the financial system is starting to accept bitcoin. Bitcoin futures / options / ETFs are all available now, large 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. But we are currently in a crypto-recession, and once we get out of it, Bitcoin could be an even better hedge.”
It is perhaps in part that Bitcoin’s relative childhood, combined with its volatility and questions about its intrinsic value, has left some experts skeptical. The key 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 economically and in broader payment systems, has gained momentum around the world.
The tone of the conversation around it has led to wide buy-ins from retailers and institutions, many of whom are convinced of the returns it can provide. Should this momentum restore or even surpass previous heights, the debate over whether this is an effective hedge against inflation may resurface with greater force.
For now, it looks like the jury is still out.