Cryptocurrency's role as a potential hedge against inflation is a hot topic in finance. The relationship between inflation and the crypto ecosystem is complex and influenced by several factors, including fiscal policies and supply shocks.
Historical data shows a low correlation between the daily returns of crypto assets and inflation expectation indices, suggesting the link between inflation and cryptocurrency may not be straightforward. However, there are cases where crypto assets have been used as an alternative to holding the domestic currency in developing economies facing high inflation.
A study by S&P shows that if crypto follows the path of “digital gold”, returns should be positively related to changes in US inflation expectations. However, the correlation is currently relatively low.
Supply plays a crucial role in crypto markets, with new coins being minted through proof-of-work mining or proof-of-stake validation. Bitcoin supply will continue to increase until about 2140, affecting its role in hedging against inflation.
Crypto assets have been used in developing economies to combat very high inflation levels, rapid currency depreciation, or stringent capital controls. This underscores emerging markets as prominent players in cryptocurrency trading.
While the data may suggest complexities in the relationship between crypto and inflation, it's essential to do thorough research and consult with a financial advisor before making any investment decisions.
In the current economic landscape, the threat of inflation remains constant, eating the purchasing power of your money. Historically, individuals have sought refuge in assets like gold—a finite and tangible resource immune to government manipulation. As inflation overflows, the intrinsic value of gold has repeatedly proven to shine brighter, serving as a reliable store of value when currency declines to mere paper. Today, in the depth of increasing inflation rates globally, time is of the essence; standing idle may risk your financial stability, urging a swift and decisive move to shield your wealth from the encroaching storm of inflation.
Innovative options have emerged, offering potential fortresses against the relentless tide of inflation. The stock market, while turbulent in the short-term, historically ascends in value over extended periods, even amidst high inflation. Then comes Bitcoin and other cryptocurrencies—decentralized, global digital assets designed to be impervious to government control and immune to traditional inflationary pressures. Bitcoin not only serving as a potent hedge against inflation, but also as a vehicle for unprecedented wealth generation. However, with great potential comes inherent risk.
Deep Dive: The Potential of Cryptocurrencies as Inflation Hedges in 2023?
Cryptocurrencies have been a hot topic in the financial world for several years now, and their popularity only seems to be growing. One of the questions that often comes up in discussions about cryptocurrencies is whether they can be a hedge against inflation.
Inflation is generally associated with an overheated economy after expansionary monetary and fiscal policies have increased aggregate demand. In some cases, it is also the result of negative supply shocks. Fiscal policies that increase disposable incomes above sustainable levels raise consumption, leading to demand-driven inflation.
They also boost investment, including in assets that generate higher returns, such as crypto. In this blog post, we will explore the relationship between inflation and the crypto ecosystem and whether cryptocurrencies can be a good hedge against inflation.
Analyzing the Relationship Between Inflation and the Crypto Ecosystem
Based on S&P's analysis, the relationship between inflation and the crypto ecosystem is complex. S&P analyzed the relationship over the past six years, which featured a transition from low inflation pre-pandemic to markedly high rates. They also used the relationship between inflation and gold since 1982 as a comparison.
If crypto follows the path of “digital gold”, returns should be positively related to changes in US inflation expectations. For average US inflation expectations, S&P used 2-year and 10-year breakeven inflation rates, derived from the relevant Treasury Constant Maturity Securities and Treasury Inflation-Indexed Constant Maturity Securities.
The rates measure inflation expectations in the short and longer term. S&P used US inflation expectation as crypto tends to be priced in dollars and the market for financial instruments linked to inflation is liquid and well established. In countries with unstable currencies, crypto assets potentially offer an alternative for preserving purchasing power.
The Historical Correlation Between Crypto Assets and Inflation Expectation Indices The historical correlation between the daily returns of crypto assets and the inflation expectation indices is low, around 0.10. Looking at rolling three-month returns for crypto assets and inflation indices shows no conclusive pattern. There is a notable number of periods where returns on crypto and inflation indices exhibit opposite signs, meaning an increase in inflation expectations is not associated with an increase in cryptocurrency prices. However, there are also periods where the two measures are both positive or both negative.
Overall, S&P's analysis suggests that the relationship between inflation and the crypto ecosystem is complex, and the data may be too short to confidently address whether crypto assets can be a good hedge for inflation. While Bitcoin and other crypto assets should be less correlated to instabilities in a financial system due to their decentralized nature, the historical correlation between the daily returns of crypto assets and inflation expectation indices is low.
The Role of Supply in Crypto Markets
It’s also worth noting that supply matters in crypto markets, even if this isn’t directly analogous to inflation. New coins are minted with proof-of-work mining or proof-of-stake validation. Supply of Bitcoin increases because miners get newly minted coins in return for their work. These rewards continually decrease and they will eventually end in about 2140. Ether, on the other hand, has recently had brief periods of burning more than minting. This will likely continue going forward.
The Use of Crypto Assets in Developing Economies
In developing economies, there are cases in which crypto assets have been used as an alternative to holding the domestic currency amid very high levels of inflation, rapid currency depreciation, or stringent capital controls. This could underpin reports that emerging markets rank among the top countries for cryptocurrency trading. Still, in some countries, cryptocurrencies may also be used to bypass financial sanctions, which complicates the study of crypto as a counter-inflationary asset.
The relationship between inflation and the crypto ecosystem is complex, and the data may be too short to confidently address whether crypto assets can be a good hedge for inflation. While Bitcoin and other crypto assets should be less correlated to instabilities in a financial system due to their decentralized nature, the historical correlation between the daily returns of crypto assets and inflation expectation indices is low. However, in developing economies, crypto assets have been used as an alternative to holding the domestic currency amid very high levels of inflation, rapid currency depreciation, or stringent capital controls. It's important to keep in mind that supply matters in crypto markets, and the supply of Bitcoin will continue to increase until about 2140.
Disclaimer: The content of this article is for informational purposes only and should not be construed as financial or investment advice. Always conduct your own research and consult with a qualified financial advisor before making any investment decisions.