Bitcoin is often referred to by its supporters as “digital gold.” That’s a lofty claim considering the cryptocurrency is just 13 years old while gold has been around for thousands of years.
Any asset, including bitcoin, looking to compete with gold should offer one of bullion’s primary benefits: Inflation protection. So this should be the ideal environment for bitcoin to strut its inflation-fighting credibility and perhaps lure some investors away from gold. However, the digital asset isn’t keeping pace when comes to damping inflation.
After a disappointing showing in 2021 as inflation and other commodities soared, gold is getting its act together this year as highlighted by a year-to-date gain of 5.5% for the SPDR Gold Shares (NYSEARCA:GLD), the largest bullion-backed exchange traded fund.
Understanding Source of Bitcoin’s Inflation Failure
Bitcoin being a disappointment on the inflation front isn’t necessarily a broader criticism of the asset’s long-term potential nor is it all that surprising when considering its relative youth and roots in technology.
“The Bitcoin protocol is codified to be deflationary. New bitcoins are mined using computing power, and the mining rewards are predetermined—the reward halves every four years; hence, the new supply of bitcoin halves—making Bitcoin’s issuance schedule consistent and predictable,” notes Alice Liu, WisdomTree Europe senior associate, cryptocurrency investments.
In theory, bitcoin’s roots in technology should make it a decent if not ideal inflation hedge, but that’s not the case this year. Part of the reason is that the digital currency isn’t all that correlated to commodities or, surprisingly, technology stocks.
“The current inflation rate is around 7.9% in the U.S., 5.8% in the euro area, 6.0% in India and 5.5% in the U.K.5 Geopolitical risks have pushed energy and commodity prices even higher, suggesting a likely continuation of higher inflation further into 2022,” adds Liu. “Different asset classes have reacted differently to this renaissance of inflation. “Interestingly, bitcoin’s price has not followed other inflation-hedging instruments like gold or commodities; neither has it appeared to be highly correlated with risk assets like tech stocks.”
As advisors well know, inflation is a drag. Clients are feeling the effects of it on a daily basis. Yes, it’s been lingering for more than a year, but owing to bitcoin’s lack of age and the length of the current inflationary environment, it may be prudent to not be too harsh regarding bitcoin’s inflation-fighting credentials or lack thereof.
“2021 is too short a period to assess whether bitcoin is an inflation hedge. The global market hasn’t seen this high of an inflation environment since 1982,” notes Liu. “Yet, besides inflation, there are geopolitical factors, post-COVID-19 economic recovery and other macro factors driving asset performances. Indeed, this may be the reason why gold, as a traditional inflation hedge, did not react until 2022 to the high inflation.”
Don’t Give Up on Bitcoin’s Inflation-Beating Potential
Investors are understandably frustrated that bitcoin is disappointing when it comes to thumping inflation. However, that doesn’t mean it won’t evolve into an inflation-fighting asset over time.
“Investors habitually invest in gold, real estate, commodities and other real assets to protect against future inflation. 2021 created a set of complex market conditions that provided the opportunity to introduce bitcoin and other crypto assets as a potential investment idea,” concludes Liu. “This nascent asset class introduces a liquid VC-like growth potential for investors to access disruptive blockchain technology.”
Bottom line: The broader bitcoin case remains intact and its ability to thwart inflation could well evolve with time.