Crypto has not been the inflation hedge it was made to be. Here’s what it means

Historical inflation is pushing the price of almost everything higher than it has been for several years. Apart from the crypto market, which is moving rapidly in the other direction.

Bitcoin saw a drop of almost 40% in June, reaching a low below $ 18,000. Ethereum’s price fell by almost 50% in June, going as low as around $ 900 at one point. Between the Fed’s regular and ongoing interest rate hikes, conflict abroad and continued supply chain disruptions, it appears that high inflation will last into 2023. It remains to be seen how ongoing inflation will affect the crypto market, but more volatility is a security bet.

Historically, cryptocurrency experts and investors have designated bitcoin, the original crypto, as an inflation hedge due to its limited supply of 21 million and speculative nature. Bitcoin’s value is in theory uncorrelated to the stock market, placing it in a category of investments known as “altars” (alternatives) along with art, wine and precious metals.

But the crypto market has increasingly followed the stock market in recent months, suggesting that it is not as volatile as early users say. In May, an algorithmic stablecoin known as Terra (UST) crashed, wiping out $ 400 billion in crypto market value in a matter of days.

It has been a perfect storm, and crypto-investors have to wonder how long-term inflation can affect their holdings. To find out, we asked two financial experts how long-term inflation and crypto are related, and what investors should do to navigate the uncertainty.

How long-term inflation can affect crypto

Crypto is too young in an asset class to know for sure how inflation will affect it, says Brandon Neal, CEO of the Euler DeFi lending protocol and former trader at the Federal Reserve Bank of New York.

“It may not have been necessarily true that crypto was a good hedge of inflation. It may just have been coincidental, and until now crypto was just so as it was a good inflation hedge, says Neal to NextAdvisor.

For example, look at gold: “If you just decided to pick points in time, certain data points throughout history, you can sometimes look at gold and say that it is an excellent inflation hedge – but you have to ignore all the times it was right and not at all.”

More likely, Neal claims, is that bitcoin has created the illusion of a hedge since it was first launched in 2009. But there are only 13 years of data during a period of historically low interest rates, so it is impossible to say about this will continue to be the case in the future – especially given how markets and global circumstances have changed.

Chris Brendler, CEO and senior research analyst at DA Davidson, says bitcoin can be a good hedge against inflation over time because it is decentralized and not linked to any central bank, but the current volatility and speculation in the crypto market overwhelms bitcoin’s underlying value. since it is still a new asset class.

The crypto market has been tracking the stock market lately because trading sentiment is taking over the movements in the short term, and so much of it is “tied to speculation,” Brendler said.

“If there is a lot of money printing going on, bitcoin should keep its value [over time], “he says.” What we do not know is how much of it is speculation, and we continue to see it come out. I think it will be proven over time to be an inflation hedge, but not this time. “

What does inflation mean for crypto investors?

So if bitcoin – and crypto in general – is not the inflation hedge many thought, what role does it play in your portfolio?

“If inflation erodes the value of a dollar over time, people often look for assets that can consistently grow out of rising inflation,” Lindsey Bell, chief market officer and money strategist for Ally, wrote in a February newsletter. “Crypto’s big move in a year like 2021 made some people feel that digital assets could serve that purpose.”

But as recent weeks and crashes highlight, cryptocurrency investment is still highly speculative, especially given that several of the most promising cryptocurrencies today have only existed since 2016 or later. Expect volatility to continue, experts say, especially in the midst of the broader economic uncertainty we are seeing right now.

Despite what many early believers have predicted, Neal doubts that crypto and decentralized finance (DeFi) will replace the role of legal tender – including US dollars and other fiat currencies (government currencies).

“I am very excited in the long run about the vision of crypto and additional innovations such as DeFi,” he says. “But I think it’s important to be realistic in the short and medium term that the existing system is going to exist in some form for a while. Status as a legal tender means really, really.”

But in an increasingly globalized world, this does not mean that cryptocurrencies still do not have interesting uses that can support long-term value growth.

Russia’s recent invasion of Ukraine, along with the ensuing war, provides an example of how crypto continues to offer opportunities even though the value leaves much to be desired among investors.

Anna Vladi, founder of METL, a technology development company that allows consumers to buy crypto through the Automatic Clearinghouse Network (ACH), urged its external, Ukraine-based staff member to accept part of her salary in stablecoins before the February 2022 invasion of Russia. This would, in theory, provide a way to protect some liquid assets from an invading enemy force and the insecurity that comes with war.

“I’ve always paid her by bank transfer in US dollars,” says Vladi. “But in the end, when the rumors circulated, I [asked] her … ‘Do you think maybe you want to at least partially take something in crypto because if something happens … there will be sanctions … funds will be frozen? You want options, and this way you can get out.

Vladis’ employee evacuated to Greece, where she was able to transfer her stack coins back to dollars and withdraw money. This was lucky, says Vladi, while her home country lived in fear of a bank run.

The decentralized nature of crypto makes it possible for refugees to exchange money, buy goods and exchange, says Vladi.

“Everyone downloaded MetaMask [digital wallets] and people started paying each other for different things – diapers, baby food, whatever it was… I really believe in emergencies just like this, this is when [crypto’s value] comes to light. ”

How to hedge your portfolio

So if bitcoin is not exactly the inflation hedge it has been made to be, what does it mean for investors? Is it still worth keeping in your portfolio, or sticking to an investment strategy that includes a share of crypto?

Experts say diversification is still the best inflation hedge. Diversification simply means adding a robust array of different asset classes – equities, bonds, ETFs and index funds – to your portfolio.

For crypto-curious investors, financial planners and other experts recommend keeping crypto investments at less than 5% of your total portfolio. They also say that it is smart to invest in crypto only what you would have lost if the value fell to zero. And you should not invest in crypto until you build an emergency fund and pay down high interest debt.

The majority of the investments, experts say, should live in broad-market funds that cover several sectors. ETFs can help diversify your portfolio better than picking individual stocks, and this spreads the risk (if one company fails, there are still many more who do well in your portfolio). There are even blockchain ETFs, which allow consumers to invest in companies that are known to have either invested in blockchain or that incorporate crypto-technology into their business.