Is Bitcoin The New Digital Gold To Hedge Against The Inflation?

Over many years, speculators, researchers, and others have investigated ways to mitigate the potential risk of inflation, and the solutions are typically a combination of several asset classes (stocks, gold, or income) depending upon the shock and geographic condition. 

However, in recent years, Bitcoin has attracted a lot of attention and is now viewed as a currency that may be used to protect us against inflation. 

Bitcoin is the original Cryptocurrency that was founded in 2009. The reason behind the rise of bitcoin is that we can quickly transfer money across borders and it has very low charges as there are no legal entities involved.

 

Bitcoin is restricted to 21 million units, which state that after the final bitcoin is sold there will be no more available for purchase. It was designed to constantly store purchasing power and the government or central bank has no role in reducing it unlike, fiat currencies are unlimited and their purchasing power will diminish when inflation occurs.

Source: www.statista.com

The number of individuals purchasing bitcoin is steadily rising throughout the world, with over 81.33 million people as of February 7th, 2022. This rise was driven mainly by heavy purchases of huge companies like Tesla and MicroStrategy Inc and investors who believe bitcoin can hedge inflation. 

Both gold and bitcoin drew attention as an alternative to hedge inflation against the stock market after the 2008 financial crisis. 

Gold is enticing because it has a low level of volatility, a low correlation, and a favourable skewness. It functions as an inflation hedge against equities but does not behave the same against bonds. It has gained the reputation of an inflation hedge with its long profound history. 

Source: www.coindesk.com

Bitcoin is commonly considered as a hedge to inflation substantially because of its limited mining, but its increasing association with the stock market presents it as more of a diversification asset. It is also incredibly volatile; its price was on the verge of exceeding $69,000 per bitcoin in November 2021 and is now dropped to $41,826.20 as of today. 

According to the present research, Bitcoin could play a role of a macro hedge against a high level of realised inflation when there is a bullish market in Europe, Japan, and the United Kingdom, where the GBP Bitcoin is the most effective and the Euro Bitcoin is the least effective. 

In contrast, in the United States, if the predicted inflation rate is less than 2% of the Federal Reserve's goal, bitcoin may work as a hedge, and if the rate rises, the USD bitcoin will continue to perform poorly. 

Now let’s look at what’s actually happening in the real world, The United States CPI index has peaked at 7.5%, this index state how much the people in the U.S have to spend to purchase goods and services. 

Historically bitcoin has proven to store value in a longer horizon, but in recent months, Bitcoin has surely seen a peak but it's now falling intensely. It has commonly viewed as a “ speculative asset ” this is one of the reasons behind bitcoin’s high volatility, it changes its price hourly and on the other hand gold is less volatile. 

We cannot decide if bitcoin can shield us against extreme prices considering bitcoin is still in its developing stage, we haven’t actually experienced using bitcoin in very high inflationary circumstances, and it lacks the crucial history that gold has. 

So thinking of bitcoin as digital gold only based on its scarcity, as gold does, is apparently incorrect. 

“If I wanted to keep my money safe I’d rather be keeping it in an Amazon Stock than Bitcoin”, said Kostovetsky to Fortune over the phone. 

Neither of these indicates that we cannot use bitcoin to dodge inflation. It can retain its value over a long period, as it has in the past; the high volatility is due to the fact that it is a relatively new product and digital money that we cannot touch or see, so many are still unsure of how it will perform. 

To become an absolute hedging tool, bitcoin must be widely acknowledged, should have absoluteness of its regulatory, freely accessibility and should outnumber its attraction of speculative assets. 

Finally, bitcoin currently cannot hedge inflation but can we use cryptocurrencies to diversify traditional asset portfolios and elevate returns?

References: 

Bloomberg.

Godbole, O., 2022, ‘The 3 Reasons Behind Bitcoin-Holder El Salvador’s Deteriorating Creditworthiness’, CoinDesk, URL: https://www.coindesk.com/markets/2022/01/20/the-3-reasons-behind-bitcon-holder-el-salvadors-deteriorating-creditworthyness/ 

Lucey, B., 2011, ‘What do academics think they know about gold?’, URL: http://www.tara.tcd.ie/bitstream/handle/2262/59296/What%20Do%20Academics%20%28Think%29%20They%20Know%20About%20Gold%3F.pdf?sequence=1 

Matkovskyy, R. and Jalan A., 2021, ‘Can Bitcoin Be an Inflation Hedge? Evidence from a Quantile-on-Quantile Model’, URL: https://www.jstor.org/stable/48618930?seq=1 

Choi, S. and Junhyeok, S., 2021, ‘ Bitcoin: An inflation hedge but not a safe haven’, URL: https://www.sciencedirect.com/science/article/pii/S1544612321003810 

Attlee, D., ‘US inflation breaks 40-year record: Can Bitcoin serve as a hedge asset?’, COINTELEGRAPH, URL: https://cointelegraph.com/news/u-s-inflation-breaks-40-year-record-can-bitcoin-serve-as-a-hedge-asset 

Smales, Lee A., 2021, ‘Cryptocurrency as an Alternative Inflation Hedge?’ , URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3883123