Bitcoin and Ethereum were potential inflation hedges, what went wrong?

In 2022, BitcoinBTC
and EthereumETH
both have lost around two-thirds of their value for the year so far. It is at a time when inflation in the US is around 8% and market risk is elevated. What happened to these cryptocurrencies as a store of value?

Volatility in cryptocurrency is not new

It’s worth noting that this level of volatility is nothing new. For example, bitcoin has seen drawdowns of over 60% in 2020, 2018, 2015 and 2014. Often, sharp increases in the value of cryptocurrencies can attract more attention, but we have seen similar sharp drops in value before. It can be hard to get a stomach, but it’s nothing new.

What is arguably different this time is the extended progressive decline over a period of months, although price trends in 2015 were quite similar. Still, history suggests that crypto hasn’t performed well as a store of value in recent years, so 2022 isn’t a huge surprise.

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Digital gold?

Those who expect cryptocurrency to hold up during times of market stress often think of it as digital gold. Here it is important to remember that gold has not had an inspiring year either, currently falling around 6% this year.

Yes, it is far better than bitcoin and ethereum’s performance, but many assets have lost money this year, be it stocks, bonds or options. It has therefore been a challenge to deliver a good result in 2022.

A stronger dollar

The strong dollar has not helped. As the dollar has strengthened, most assets priced in dollars have weakened. For example, if you look at the price of bitcoin in euros, the decline is about 10% less than in dollars, consistent with currency swings we’ve seen this year.

As much as inflation in the US has increased, the dollar has held up well, as the US central bank has raised interest rates faster than many countries, and the dollar has been perceived as a safe haven currency compared to many others.

Adoption continues

At the same time, the broad adoption of cryptocurrencies in the more mainstream financial system continues. It’s been a year since the US saw the first Bitcoin ETF, bitcoin can now be part of 401(k) plans and this summer BlackRock partnered with Coinbase to offer cryptocurrencies to institutional clients. So the acceptance of cryptocurrencies in the mainstream financial system, with associated regulation, continues.

So while cryptocurrencies may eventually become stores of value, bitcoin and ethereum continue to behave far more like risky assets. For example NASDAQNDAQ
the technology stock index is down nearly 40% this year at the time of writing, not far off the lackluster performance of bitcoin and ethereum.

However, severe depreciation is not necessarily a reason to write off these assets. We have seen similar falls at least four times in the last decade, and if anything cryptocurrencies are now more interested in the financial and investment system than before.

They also continue to offer a diverse return stream. For example, since June of this year stocks and bonds have generally sold off. At the same time, cryptocurrencies have actually been somewhat stable, despite heavy losses earlier in 2022.

Finally, of course, despite being huge throughout their existence, both cryptocurrencies have shown huge increases in value over the longer term. 2022 may be a disappointment, but it is not a major change in the history of high volatility we have seen in cryptocurrency assets.