From turkeys to gasoline, clothing to dollar stores, almost every avenue of human activity has been hit by the inflation spectrum. Globally, rising inflation rates are disrupting purchasing plans and spending.
In the face of this inflation inferno, consumers and institutions holding devaluing fiat currencies have been looking for alternatives to hedge against. Bitcoin and many other cryptocurrencies are the current weapons, which drive the US Securities and Exchange Commission to embrace crypto as an investable asset class.
Bitcoin has witnessed strong returns so far this year, and has exceeded traditional hedges by accumulating over 1[ads1]30% compared to gold’s meager 4%. In addition, increased institutional adoption, persistent appetite for digital assets based on weekly inflows and increasing exposure in the media bitcoin case strengthened among weary investors.
If these are moves made by big money, they must be smart moves. But while the prospect of hedging against bitcoin may seem tempting to retail investors, there are still some questions about its viability to reduce financial risk for individuals.
Incorrectly calculated expectations
The ongoing discussion about bitcoin as an inflation hedge must begin with the fact that the currency is often susceptible to market turmoil and fluctuations: Bitcoin’s value fell above 80% during December 2017, by 50% in March 2020 and by a further 53% in May 2021.
Bitcoin’s ability to improve user returns and reduce long-term volatility has not yet been proven. Traditional hedges such as gold have shown effectiveness in preserving purchasing power during periods of persistently high inflation – take the United States in the 1970s as an example – something bitcoin has not yet been tested on. This increased risk again makes the return subject to the drastic short-term fluctuations that sometimes affect the currency.
It is far too early to consider that bitcoin is an effective hedge.
Many argue for bitcoin based on the fact that it is designed for a limited supply, which supposedly protects it from devaluation compared to traditional fiat currencies. Although this makes sense in theory, the price of bitcoin has proven to be vulnerable to external influences. Bitcoin “whales” are known for their ability to manipulate prices by selling or buying in large quantities, which means that bitcoin can be dictated by speculative forces, not just the money supply rule.
Another important consideration is regulation: Bitcoin and other cryptocurrencies are still at the mercy of regulators and widely varying laws across jurisdictions. Anti-competitive laws and short-term regulations can significantly impede the introduction of the underlying technology, and potentially further weaken the asset’s price. All this is to say one thing: It is too early to consider that bitcoin is an effective hedge.
Catering to the rich
Against the background of this debate, another prominent trend has driven the momentum. As bitcoin’s popularity grows, it continues to drive the adoption and institutionalization of the currency among consumers, including more affluent individuals and companies.
A recent survey found that 72% of UK financial advisers have informed their clients about investing in crypto, with almost half of the advisers saying they thought crypto could be used to diversify portfolios as an uncorrelated asset.
There has also been a lot of advocacy for bitcoin from productive individuals, known for being technologically progressive, namely billionaire Wall Street investor Paul Tudor, Twitter boss Jack Dorsey, the Winklevoss twins and Mike Novogratz. Even powerful companies such as Goldman Sachs and Morgan Stanley have expressed interest in bitcoin as a viable resource.
If this momentum continues, bitcoin’s notorious volatility will gradually disappear as more and more wealthy people and institutions hold the currency. Ironically, this increase in value on the network would lead to the concentration of wealth – the antithesis of what bitcoin was created for, subject to the influence of the elite and exclusive 1%.
In line with classical schools of financial thinking, this would in fact expose retail investors to greater risk, as institutional buying and selling would resemble whale-like market manipulations.
Defies the core ethos
Bitcoin’s growing popularity will undoubtedly lead to more people owning it, and it can be argued that those who have the most money will be the ones who (as usual) will end up owning the most.
This noticeable shift of influence towards individuals and firms with ultra-high net worth among bitcoin and other cryptocurrencies runs counter to the very ethos on which Bitcoin White Paper was based when it described a peer-to-peer electronic cash system.
Among the basic rationale for cryptocurrencies is their need to be unlicensed and resistant to censorship and control by a given institution.
Now, while 1% are seeking a larger share of the cryptocurrency, they are raising the prices of these assets in the short term in a way that traditional and less influential retail investors are not capable of.
While this move would undoubtedly make someone richer, there is an argument that could be made that this could leave the market at the mercy of 1%, contrary to Bitcoin’s intended vision.