Is Bitcoin a hedge against inflation?

by James · October 17, 2022

Tired of hearing about inflation? Well, the latest set of statistics show that while inflation is slowing, standing at around 8% today, it is not slowing at the expected rate and is still some way off where officials want it to be. And as long as inflation remains high, markets are likely to struggle as investors try to de-risk their portfolios.

First, let’s discuss the problem of inflation. When inflation is high, you lose purchasing power. The increased supply of money means that goods and services cost more. This means you’re not as likely to save as much, and the dominoes then start to fall from there.

So, which assets are inflation-proof or at least inflation-resistant? One that might come to mind is Bitcoin (BTC 0.78%), the most valuable cryptocurrency today. It has been touted as a hedge against inflation since it was created in the wake of the Great Recession of 2009. Yet Bitcoin has lost nearly 70% in the past year – not such a hedge it seems.

But when we take a more expansive and in-depth view, we can get a better idea of Bitcoin’s potential as an inflation hedge. Before we start, we should look at the characteristics that make Bitcoin so unique, then we can get into the numbers.

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It’s in the code

First, Bitcoin has a limited supply. The code is programmed so that there will only ever be 21 million Bitcoins in circulation (about 19 million are in circulation now). In addition, these 21 million are set to be released on a defined schedule where fewer and fewer Bitcoins enter circulation around every four years.

This four-year cycle is known as the halving. Bitcoin miners earn a reward for successfully “mining” or verifying transactions for the next block on Bitcoin’s blockchain. Initially, miners earned 50 bitcoins. About four years later, it was halved to 25 bitcoins. Enough time has passed that today miners earn only 6.25 bitcoins. Sometime in May 2024, when the next halving happens, this reward will drop to 3,125 bitcoins.

Bitcoin vs. Fed

This fixed schedule drives a simple characteristic that Bitcoin advocates believe does not exist in the US dollar: supply and demand. Over the last decade or so, the Federal Reserve (the people in charge of US monetary policy) took an experimental approach known as quantitative easing to stimulate the economy. Without getting too into the weeds, this strategy led the central bank to buy securities such as bonds, injecting more money into the economy.

It is Reader’s Digest version of quantitative easing, but we can see the effects by taking a look at the Fed’s balance sheet. Balance sheet expansion began to take place after the Great Recession, but with the onset of the COVID-19 pandemic, the balance sheet grew remarkably quickly as the central bank began buying more securities. Fed Chairman Jerome Powell said in an interview that the post-Covid balance sheet expansion was “significantly greater” than in the aftermath of the Great Recession. Since 2008, the Fed’s balance sheet has grown by more than 300%, and most of this growth has occurred in the last three years.

While some proponents of quantitative easing may have seen it as a necessary sacrifice to ensure that businesses and families were able to stay afloat through the pandemic, it did not come without consequences, and it has manifested itself in the form of inflation.

Bitcoin is moving forward, slowly but steadily

Although markets around the world have been spooked by inflation, we can see that even with the recent drop in price, Bitcoin is performing exactly as it was designed for. Newer Bitcoin investors are likely to be at a loss. But those who have invested in the last three, four, five or even 10 years are sitting on huge gains. And it comes down to one simple dynamic: supply and demand.

If current trends continue, there should be increased demand for the world’s most valuable cryptocurrency. And with limited growth in supply, this price increase should outpace inflation. So yes in the short term Bitcoin has not been a good hedge against inflation, but when we evaluate over a longer period, that narrative changes.

To get a better idea, let’s look at the price of Bitcoin before the Fed embarked on its last round of quantitative easing in the spring of 2020. Bitcoin’s price hovered around $9,000 at the time; today it stands at around $19,000. Go back to 2009 when quantitative easing began and Bitcoin was worth mere pennies, and it becomes even clearer that it is capable of outperforming inflation.

Bitcoin’s inherent properties help drive its value over the long term. When considering the Fed’s recent approach to monetary policy, some of the main reasons behind Bitcoin’s creation become more obvious: to circumvent currency depreciation and ensure that your hard-earned money holds its value.