Why Bitcoin’s case as an inflation hedge fell apart

[ad_1]

Not so long ago, many investors viewed Bitcoin (CRYPTO:BTC) as an ideal hedge against inflation. They felt that cryptocurrency was like gold – long considered a strong hedge against inflation – in one important way. Bitcoin was a finite resource, with a maximum of only 21 million coins allowed to exist.

However, this theory does not claim the luster it once had. Here’s why Bitcoin’s case as an inflation hedge fell apart.

Image source: Getty Images.

The numbers don’t lie

Inflation has remained low throughout the past decade. During this time, Bitcoin made impressive gains. There was no compelling reason to dismiss the idea that cryptocurrency could serve as a good inflation hedge with inflation rates at historically low levels.

Then the COVID-19 pandemic changed everything. The federal government, spooked by the economic impact of the pandemic, responded with unprecedented stimulus packages. At the same time, supply chain disruptions have prevented many companies from meeting demand. After a long hibernation, inflation has started to rear its ugly head again.

It was the perfect scenario for Bitcoin to show how great an inflation hedge it could be. But that was not the case.

Bitcoin Price Data by YCharts

No, Bitcoin has not completely collapsed. However, over the past 12 months, cryptocurrency has taken investors on a roller coaster ride. It’s up, but only a little over 20%. Bitcoin is currently near its lowest level in six months.

The rate of inflation, however, has more than quintupled over the same period. The numbers don’t lie: Bitcoin has proven to be an abysmal hedge against inflation.

Bitcoin’s underlying problem

Why isn’t Bitcoin better at protecting against inflation? We can easily rule out a possible reason. It’s not that a lot of new digital coins have been mined. The number of Bitcoins in circulation has increased by less than 1.8% over the past 12 months.

The main underlying issue for Bitcoin is that for an asset to be an inflation hedge, investors must actually believe that it will hold its value as inflation rises. It is quite clear that this is not the case with Bitcoin.

Bitcoin only has value if investors believe it. It has no real intrinsic value like stocks.

Investors believe that cryptocurrencies, in general, are risky and volatile. And they seem to bundle Bitcoin with all other digital coins. Bitcoin has fallen by roughly the same amount as some altcoins such as Dogecoin over the past three months.

A waiting hedge?

However, don’t throw in the towel on Bitcoin as an inflation hedge just yet. It’s still possible that cryptocurrency could be exactly what investors once hoped for.

Increased adoption of cryptocurrency would help. The more utility Bitcoin has in the real world, the more justifiable its valuation will be. At some point, the valuation of the digital coin might become more stable.

If and when that happens, Bitcoin’s fluctuations could be inversely correlated to inflation rates much more than they currently are. Cryptocurrency is not yet an inflation hedge, but it could well be a waiting hedge.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

[ad_2]