Is Bitcoin a good hedge against inflation?

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One of the common investment theses behind Bitcoin (CRYPTO: BTC) is that it is an excellent hedge against inflation. There is only 21 million Bitcoin available once they are all mined, which limits the supply. In theory, this limited supply should mean that Bitcoin is a good hedge against the increasing supply of the US dollar.

This theory is called into question when we examine the data on Bitcoin price trends and actual inflation. Does Bitcoin really trade as an effective hedge against inflation, or is there something else in its movements?

Image source: Getty Images.

Why Bitcoin Is Considered A Hedge Against Inflation

The theory behind Bitcoin as an inflation hedge is pretty straightforward. The number of Bitcoin is limited to 21 million, while the number of US dollars generally increases over time. All other things being equal, if the supply of the US dollar increases, the value of Bitcoin in dollars should also increase.

Here is an extremely simplistic example of the value of Bitcoin if the supply of dollars doubles. I’m assuming that the “market cap” of the US dollar and Bitcoin is equal in both scenarios.

Currency Supply Scenario 1 Price Scenario 1 Supply Scenario 2 Price Scenario 2 US Dollar $ 1,000 Billion 1 $ 2,000 Billion $ 1 Bitcoin 21 Million $ 47,619 21 Million $ 95,238

Note: Author’s calculations.

If the supply of US dollars doubles, it makes sense for the value of a Bitcoin to double against the US dollar. However, the market does not always work in this simple way.

Bitcoin hasn’t been a hedge until now

Looking back to the pre-pandemic days, Bitcoin doesn’t look like a hedge at all. Bitcoin gained popularity at the end of 2017, but then crashed in 2018 and early 2019, and it had nothing to do with inflation. During this period, M2 money supply increased by 25.3% and gold would have been a better direct hedge, up 51.9%.

Bitcoin price data by YCharts

More recently, Bitcoin has not acted as a hedge as real inflation has set in. You can see below that inflation and inflation expectations have been rising throughout the year, but Bitcoin is actually down from the end of February. Investors looking to hedge against inflation would have been better off buying the iShares TIPS Bond ETF (NYSEMKT: TIP), a bond fund made up of inflation-protected treasury bills.

Bitcoin price data by YCharts

What is Bitcoin if it’s not a hedge?

Over the past decade, we have seen Bitcoin’s value fluctuate wildly. However, it was not correlated with inflation significantly. You can see below that Bitcoin has not been consistently correlated with growth or inflation stocks and for much of the past year has been negatively correlated (a correlation coefficient of 1.0 means that they are strongly correlated while a coefficient of -1.0 means that they move in opposite directions).

Fundamentals of Charts by YCharts

I see the recent rise in Bitcoin as a speculative move driven by millions of people with excess stimulus cash and enough time to trade in the high-flying cryptocurrency market. It brought in more institutional money, pushing stocks even higher. Ultimately, it’s not clear whether Bitcoin is like digital gold, some sort of utility, or just a speculative asset.

From what I can see, based on the fact that inflation rises in 2021 while Bitcoin falls, Bitcoin is not a good hedge against inflation, and investors should look for a better investment thesis. for this digital asset.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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