In theory, bitcoin has shown to be a great inflation hedge in the past. Economic agents typically invest in so-called ‘safe heaven assets’, such as precious metals, real estate, and cryptocurrency like Bitcoin, to hedge against inflation. Bitcoin has worked as a hedge against inflation, political unrest, and social unrest, all of which are elements that typically cause inflation to soar. Recent societal events have undermined bitcoin's potential to operate as a safety net, prompting many to doubt its efficiency as an inflation hedge.
Bitcoin as a hedge against inflation
Bitcoin is viewed as an inflation hedge due to its restricted supply, which is usually unaffected by price, and its relative attractiveness when real yields approach zero or below. However, purchasing bitcoin isn't solely for hedging against inflation. Bitcoin is also purchased to protect from all of the terrible effects that come with it. This is the reason behind the cryptocurrency's popularity.
Bitcoin is typically used as an inflation hedge to safeguard against the effects of out-of-control inflation/runaway, not just any inflation. Inflation isn't always a negative thing. The rise in general prices that leads to economic growth and low unemployment, as well as helping to reduce the supply-demand gap and encourage investment, is referred to as "good inflation."
Runaway inflation on the other hand exacerbates poverty, heightens uncertainty, demolishes trust in institutions and can lead to the breakdown of social order. Zimbabwe is an example of a country experiencing such inflation which rose from 96.4% to 132% on a year-on-year basis within a few months in 2022. In such a situation, economic agents will be justified in their use of a ‘stable’ cryptocurrency.
Bitcoin can also be used as a buffer against insecure governments that freeze bank accounts, police states that wish to take private money, paranoid leaders who want to disenfranchise opponents, and export-protecting devaluations that lead to greater inflation. As a result, Bitcoin provides a hedge against inflation, political instability, and social turmoil, which is not an absurd thing to plan for if inflation returns.
Investors looking for assets that can provide shelter during the ‘storm’ and a hedge against macro events as a result of Covid-19's economic effects and the Russia/Ukraine war crisis have found solace in investing in Bitcoin. Bitcoin and cryptocurrencies have been advocated as an inflation-resistant hedge against a backdrop of declining GDP, economic slowdown, government bailouts, and fiscal stimulus or money printing.
Investing in bitcoin is similar to investing in any other asset. It is expected that demand for it will expand in the months and years ahead, resulting in a price increase. This allows sellers to recoup their investment by selling the asset for more than they paid for it. In this sense, Bitcoin trading is rife with speculation, which makes markets unstable.
Bitcoin is seen as a promising investment and a haven from traditional assets. Bitcoin has been hailed as a possible alternative to many well-known stock exchanges throughout the world that are suffering problems. Many investors have even advised others to shift their investments to crypto in the aftermath of the Covid-19 debacle. Former Goldman Sachs fund manager Raoul Pal, for example, transferred 25% of his portfolio to Bitcoin, demonstrating the currency's growing appeal.
Furthermore, because the number of new coins supplied to miners is halved every four years, Bitcoin's supply decreases with time. As a result, Bitcoin's stock-to-flow ratio is rising, indicating the number of years required to obtain the present supply at the current production pace. Bitcoin's stock-to-flow ratio has reached 50 (years), putting it on par with gold.
Bitcoin and other cryptocurrencies come with several well-known risks. Scams have been detected, and the price could plummet dramatically. There are also technological risks. An owner's Bitcoin stash can be wiped out by a damaged hard drive or an online hacking incident, leaving them with no recourse. Bitcoin and other cryptocurrencies like Litecoin and Ethereum are digital forms of money stored in wallets. Bitcoin wallets, like other files, can be stored locally, such as under a mattress on a hard drive, or in the cloud, and, like money, Bitcoin can be lost or stolen.
Sometimes hard drives with wallets fail. Opening a leather wallet and realizing that your paper money has disintegrated is similar to having a hard drive with Bitcoin fail—except that $20 bills haven't increased in value by 20,000% in four years. These are just a handful of the risks that come with bitcoin.
On June 12th, the price of bitcoin and other cryptocurrencies fell as a large cryptocurrency lender virtually failed and froze all withdrawals from its platform, claiming adverse market conditions. This is the most recent high-profile collapse of a bitcoin industry pillar. These financial meltdowns have wiped out tens of billions of dollars in investor assets, prompting urgent calls for regulation of the unregulated industry. Such occurrences are what have led to Bitcoin's safety being doubted.
Late Monday, June 13th, bitcoin was trading for around $22,400, down more than 16% from the previous day. Another highly followed cryptocurrency, Ethereum, was down nearly 17%. As the Federal Reserve raises interest rates to battle excessive inflation, investors have been selling riskier assets such as digital currencies and technology companies.
Celsius Network, a cryptocurrency lending platform, said on Sunday, June 12th, that it was halting all withdrawals and transfers between accounts to honour withdrawal obligations over time. Celsius, which has over $10 billion in assets and 1.7 million subscribers, offered no indication in its announcement of when members might be able to access their accounts.
This is the cryptocurrency world's second major crash in less than two months. In early May 2022, the stable coin Terra crumbled, wiping out tens of billions of dollars in a matter of hours. Because they're supposed to be backed by actual assets like a currency or gold, stablecoins have been thought to be reasonably safe.
Celsius, like Terra, had marketed itself as a secure haven for bitcoin investors to store their assets. Even as Celsius was collapsing, the company's website boasted that users could retrieve their currencies whenever they wanted and that they would be safe for the rest of their lives. Such developments have astounded investors and depositors, who have questioned why their monies have not been secured.
Cryptocurrency should be avoided by investors looking for a safe investment. Traditional investors, bankers, and economists have long warned that cryptocurrencies such as Bitcoin are nothing more than sophisticated Ponzi schemes. The example of this year's second crisis should serve as a warning to any investment. Despite the popularity of cryptocurrency investing, recent developments reveal that it is a risky investment that should only be made with excess funds.