Investors now regard Bitcoin as a hedge against inflation as the dollar has lost 5% of its value already, with predictions that this is only the beginning.
During times of global economic crisis, governments print money. This leads to inflation and investors subsequently moving their investment capital in long-term, more stable investments. Historically, that has been gold, but currently, gold has been joined by another asset: Bitcoin (BTC).
There are so many reasons for this. The United States Federal Reserve is handling the crisis in a bad way, and has continued to print money. Already, the dollar has lost 5% of its value, with predictions that this is only the beginning of loss. The currency is going to shed up to 20% in the next few years, according to analysts at Goldman.
Alongside this devaluation has come another threat to investors: deflation. With the value of dollar assets dropping and the worst yet to come, investors see Bitcoin as a hedge against deflation. This appears to be the main reason why Bitcoin has retained its value despite woeful news in other parts of the economy.
Can bitcoin act as a hedge against the inflation of dollar?
Inflation and deflation
For cryptocurrency investors accustomed to dealing with hourly market movements, it can sometimes be easy to forget about the macro-level trends that drive our economy. Inflation is one of these, and it’s useful to have a broad definition of the term before we look specifically at the role of cryptocurrency against it.
Inflation generally comes about because of a general decrease in the purchasing power of fiat money. Many things can cause this loss of purchasing power: foreign investors pouring out of a particular currency, or even investors attacking a currency. Most often, though, inflation is the result of an increase in money supply, like when the Fed unilaterally prints billions of dollars and sends out checks to millions of Americans, for example.
Deflation is the opposite. In deflationary scenarios, prices decrease as fiat currency increases in value relative to different goods and services. Again, there are different causes for this, but it generally comes about due to tightly controlled fiscal policies, or technological innovation.
Coronavirus and inflation
The key point in these definitions is that inflation of dollar can only happen in fiat currencies meaning those not based on the market value of a tangible asset, but largely on confidence in growing gross domestic product. Since the Bretton Woods agreement of 1944, the latter has been the basis of the U.S. dollar’s value.
Having a fiat money gives governments a powerful degree of freedom when it comes to printing money, and so when it comes to controlling inflation. However, when confidence in the government is low, government spending programs can lead to inflation quickly getting out of control. In the 1970s, gold boomed as investors saw it as a hedge against the dollar’s rapid inflation.
This is like what is happening now. The global coronavirus pandemic has given rise to a massive inflation of dollar and aggressive expansion of money supply while prices in certain key areas such as food staples keep increasing due to supply shocks caused by lockdowns.
In this environment, we should not be surprised if gold is booming. There is, after all, only a limited supply of gold on earth, and so its price cannot easily be affected by government policy. Some crypto currencies, however, are booming apparently for the same reason. Billionaire investors are therefore lining up to compare Bitcoin to gold.
The reason why some forms of cryptocurrency can act as a hedge against inflation of dollar is precisely the same reason gold can: there is a limited supply. This is something that is often forgotten about by many, even those in the cryptocurrency space, but we should remember that many cryptocurrencies are built with an inherent limit.
The 21 million Bitcoin limit means that at a fixed point, there should be fewer Bitcoins versus the demand for them, meaning that in terms of value, the price per unit should increase as the supply decreases. Moreover, the fact that Bitcoin allows investors to limit their exposure to government surveillance networks means that, in this time of low confidence in government, many are moving their investments away from the U.S. dollar and toward bitcoin in order to avoid inflation. In other words, the comparison with gold investments of previous crises seems pretty apt.
But here’s the thing: It’s not completely clear that Bitcoin is, in fact, a deflationary asset. While it is technically true that the supply of the currency is limited, we are nowhere near that limit, with most estimates putting the last Bitcoin to be mined in 2140. What this means, in practice, is that Bitcoin will be not have the potential to act as a completely stable hedge against inflation for at least another 120 years.
This might not seem important that much, of course, but ne of the primary driving forces behind the surge of Bitcoin has been the combination of (relative) stability and (relative) variability that it can afford. In this context, it’s heartening that investors now regard crypto as a stable hedge against an inflating U.S. dollar, but to regard cryptocurrency as a replacement for gold would be to miss the point: Cryptocurrency is far more than just a hedge.