Bitcoin Faces Hedge Test Amid Rising Inflation Concerns
Opinion is split on whether we'll witness serious levels of inflation this year. There is no clear answer whether investors will be driven towards BTC if inflation accelerates. BTC could potentially emerge as a bonafide hedge in the more distant future.
Inflation — or rather, the perceived threat of inflation — has been very kind to bitcoin (BTC) and crypto. Thanks in part to the US Federal Reserve (Fed) committing to ‘unlimited’ quantitative easing and to Congress approving trillion-dollar stimulus packages, bitcoin has climbed from below USD 5,000 to above USD 61,000 in less than a year.
Much of bitcoin’s ascent has been driven by institutions and corporations, which have sought to avoid inflation and a weakening dollar. The question is: now that some economists are suggesting the COVID-19 pandemic may actually bring real inflation (and not just the threat of it), how are bitcoin prices likely to react?
Opinion is largely split on this question. Analysts (mostly in crypto) estimate that bitcoin will become even more attractive as a hedge against inflation in the coming months (and possibly years), while economists (mostly outside of crypto) don’t really regard the cryptocurrency as a genuine hedge.
Opinion is even split on whether we’re likely to witness serious levels of inflation this year, despite a recent National Association of Business Economists survey indicating a growing expectation of rising prices.
“High unemployment and a sharp decline in economic activity led to very low inflation, at times deflation, during the past year [in the United States]. Until life gets back to normal and people get back to work safely, inflation will remain subdued,” said economist Claudia Sahm.
In fact, she told Cryptonews.com that a slow global recovery would put some downward pressure on US inflation, since prices for imported goods would remain low.
On the other hand, Prof. Jon Danielsson of the London School of Economics suggested that, even if it doesn’t arrive in the short-term, we’re likely to witness inflation sooner or later.
“Inflation is certainly creeping up, and with both the Biden helicopter drop of money and the commitment to keep rates low for quite some time interacting with the post-COVID boom, there is a high risk of inflation in the medium term,” he told Cryptonews.com.
According to eToro analyst Simon Peters, we’re witnessing increasing expectations of inflation.
“We’ve seen an example of this recently where inflation expectations in the US have been increasing and in turn, seen bond yield risings. This has been particularly pronounced in the 10-year note, as investors moved out of fixed income and into assets that benefit from higher inflation conditions such as energy stocks,” he told Cryptonews.com.
US consumer prices inflation stood at 1.7% in February, having been 1.4% in January and 1.2% in October. "With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time and longer‑term inflation expectations remain well anchored at 2%," the Fed said this past March. However, many countries are already experiencing much higher inflation.
Hedge vs. not hedge
In either case, opinion is very much split on whether investors and savers will be increasingly driven towards bitcoin if inflation accelerates.
“We are already starting to see individual investors and corporations move to bitcoin as a potential hedge against a depreciating dollar. Gold used to be the go-to asset class, however some would argue that it is somewhat outdated because there is no guarantee of finite supply,” said Simon Peters.
He expects this process to intensify in the event of an inflation rate significantly above 2%.
“We only have to look at countries like Venezuela where an economy facing hyperinflation is increasingly adopting bitcoin and other digital assets to pay for everyday goods and services versus its domestic currency,” he added.
However, some economists disagree that there’s a necessary or natural link between inflation and bitcoin investment. More influential have been low interest rates and the lack of other profitable investment opportunities.
“I see no reason why the fear of inflation should drive people to bitcoin. The stock market provides a natural inflation hedge at lower risk,” said Jon Danielsson.
Such a view may appear to fly in the face of bitcoin’s price action over the past few months, yet Danielsson argues that this has little or nothing to do with inflation.
“I don’t see bitcoin as an inflation hedge. At the moment the price rises are purely due to speculation, and once the speculative fever passes, we could easily see bitcoin going down and USD inflation sharply increasing,” he added.
There may be something to this point: while companies such as MicroStrategy have cited inflation as one reason for buying bitcoin, it might be less likely that retail investors have been driven by rising consumer prices (at least in the countries with low inflation).
At the same time, there’s obviously no guarantee that bitcoin will continue rising in a world of high inflation, particularly if it’s targeted by regulation.
“Firstly, we could see government or regulatory intervention, making it harder or illegal to transact, hold or mine bitcoin. Secondly, a flaw or vulnerability in the underlying blockchain could get exploited,” said Simon Peters, who added that such scenarios would shake confidence in bitcoin. (Learn more: Here Are the Ways Governments Could Attack Bitcoin – and None of them Sound Hot)
A hedge for the future
Despite much of the current bitcoin mania being driven by a profit-motive, the cryptocurrency could potentially emerge as a bonafide inflation hedge in the more distant future.
“The world is changing and we’re seeing the younger demographic be more open to exploring technologies or systems that do not have a central authority in control, embracing the idea of a true free market economy,” said Simon Peters.
With younger generations arguably more likely to turn to bitcoin rather than gold, Peters suggests that the cryptocurrency’s reputation will only strengthen over time.
“As traction builds for bitcoin as an inflation hedge, I expect the price of bitcoin to continue climbing, particularly if we keep seeing quantitative easing and the printing of new money in economies around the world,” he added.
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