Cryptocurrencies can theoretically be a hedge against inflation, says S&P Global

Ratings agency S&P Global on Tuesday noted the appeal of cryptocurrencies as assets that protect investors from the effects of inflation, while underscoring the lack of data to support the popular narrative.

“Crypto-assets could theoretically be a hedge against inflation,” the New York-based agency said in a press release shared with CoinDesk, noting adoption in some emerging markets battling high inflation.

“Some argue that crypto-assets may be in demand in a high-interest/high-inflation environment because they can serve as a store of value. We believe the track record of crypto is too short to prove this,” the New York-based newspaper. the agency added, drawing attention to bitcoin’s (BTC) weak correlation with US inflation expectations.

Crypto devotees consider bitcoin, the world’s largest digital asset by market capitalization, as a store of value like gold, thanks to a programmed code that halves bitcoin’s supply rate every four years.

The so-called halving of mining rewards contradicts the ever-increasing fiat money supply globally. (Proposers believe that massive money printing by central banks is driving inflation). The broader crypto market, including decentralized finance (DeFi), is considered an alternative to a centralized fiat banking system.

Previous data, however, suggest otherwise. The agency’s findings show that the historical correlation between the daily return of the S&P BDMI (the agency’s crypto index) and US two-year and 10-year breakeven inflation expectations is only 0.10. The correlation between three-month rolling returns for the S&P BDMI and 10-year breakeven inflation expectations shows no decisive pattern, the agency said.

In other words, there is little association between the crypto market and inflation expectations. A strong correlation of at least 0.75 may be required to validate the inflation hedge narrative.

Breakeven inflation rates are measures of investors’ expectations of inflation over a specified period derived by subtracting the yield on inflation-protected bonds from the yield on nominal bonds.

Bitcoin’s market value fell by more than 70% last year, even though US inflation, as measured by the consumer price index, averaged 8%, per Statista.

The figure shows several periods where an increase in inflation expectations has failed to lift crypto market values. There have been periods when the two were positive or negative at the same time.

In contrast, the agency said gold’s daily returns have consistently tracked inflation expectations since 2013, adding: “There is evidence of Granger Causality between the 10-year Breakeven Inflation Expectation Index and the S&P GSCI Gold Index at a 95% confidence level.”

The Granger Causality test is a statistical hypothesis test to determine whether time series X is useful in predicting Y.

“The same test fails for Bitcoin,” S&P Global noted.

At the same time, cryptocurrencies appear sensitive to the cost of borrowing in the economy and tend to move in the opposite direction to the US two-year Treasury yield, which is more exposed to interest rate expectations than longer-dated bond yields.

“On a daily rolling three-month basis, interest [two-year yield] and the crypto index has shown an inverse relationship 63% of the time since May 2017. This increases to 75% as of May 2020, following the start of the COVID-19 pandemic, S&P Global said.