Bitcoin: Inflation Hedge or Not?

It's an article of faith among Bitcoin believers that the currency is a store of value—a safe haven that will be worth something in good times and bad.  That faith got tested, however, when an alarming U.S. inflation report on Monday led nervous investors to sell off assets of all sorts, including Bitcoin.

In theory, this shouldn't have happened. One of Bitcoin's big appeals is that it has a finite supply. Unlike central banks, which keep printing more and more money ("Fed go brrrr," as they say), only 21 million Bitcoins will ever be minted. This means Bitcoin should be a natural hedge against inflation, one that investors embrace in response to reports like the one we got this week.

So what's going on? Is Bitcoin's reputation as an anti-inflation hedge simply wishful thinking? Decrypt spoke to economists and market experts to get to the bottom of it.

One of those experts is Ed McKelvey. A former Federal Reserve economist and longtime Goldman Sachs analyst, McKelvey warns about reading too much into a one-off event like the response to Monday's inflation report. He also notes that fears of inflation may be overblown because macroeconomic forces are different than the ones that touched off spiraling prices in the 1980s.

McKelvey points out that, even though the U.S. is being flooded with dollars thanks to loose fiscal and monetary policy, there is still slack in the economy, and that the decline of organized labor means that—unlike the 1970s and 80s—wages do not increase in lockstep with rising consumer prices. As a result, runaway inflation is less of a risk than in the past, which could explain why people are not fleeing to Bitcoin.

But McKelvey does agree that Bitcoin is a store of value, and says those who embrace it behave similarly to goldbugs, who view the yellow metal as a haven in times of economic trouble. He adds that inflation is "damaging to a lot of conventional assets" like stocks and bonds, and that Bitcoin's scarcity means it's likely to fare better if inflation really does begin to bite the U.S. economy.

As for people deciding to sell Bitcoin in response to the inflation report, McKelvey notes that the cryptocurrency's potential to be a hedge may have already been baked into the price—a view shared by others.

"This might be a case of 'buy the rumor, sell the news'," says Alex Tapscott, an executive at the alternative investment fund Ninepoint Ventures, and the author of a popular book on blockchain.

Tapscott notes that the price of Bitcoin has already swelled enormously during the last six months as central banks continue to print money, and that expectations for its performance have been sky high. In light of this, he thinks that Monday's sell-off, when Bitcoin dipped around 5%, was insignificant and that the long-term outlook for the currency is extremely bullish.

"Investor sentiment is shifting towards Bitcoin as a store of value, but that doesn't mean stores of value don't sometimes go down,' he said.

There is another explanation—aside from Bitcoin's value as a hedge already being baked into the price—for the recent price drop. Joe Weisenthal, a longtime markets watcher at Bloomberg pointed to Monday's price developments on Twitter:

The reason for this, he said, is that Bitcoin has some of the same characteristic as tech stocks—namely that they're a way for investors to bet on future profits while forgoing cash flow. Unlike dividend-paying stocks, Bitcoin and most tech stocks don't generate any cash for those who hold them, which could make them unappealing at a time when inflation signs are flashing but while other sectors of the economy are healthy—an assessment that McKelvey, the former Fed economist, agrees with.

Meanwhile, others in the broader crypto economy say they are not concerned about macroeconomic factors like inflation or even the price of Bitcoin. These include Kyle Samani, the cofounder of crypto investment firm Multichain Capital.

"Our alpha comes from asset selection, not timing Bitcoin's price to the U.S. dollar. We go out of our way to avoid looking at prices," says Samani, who added, "My job is to form theses about crypto and figure out which teams reflect those." 

Samani's comments suggest that a drop in the price of Bitcoin is coming to mean less than it used to for the rapidly diversifying crypto industry.

As for Bitcoin, it appears that the popular thesis of it being a hedge against inflation largely holds up—but that it may be several years before the broader market begins to treat it that way.