Does Bitcoin Beat Inflation?

As inflation rises across the developed world and is above the range central banks are comfortable with (roughly 2-3% guidance annually vs. 6%+ actual) and billions of people suffer as their hard-earned savings are eroded, the question of whether bitcoin can be a hedge against inflation has never been more relevant. We are going to examine whether bitcoin can beat inflation or not.

1- BitcoinBTC
is procyclical due to institutional investment, and has a short-term inverse relationship with inflation increases — beating inflation in the short term cannot be said to be a hedge

The first important point to make here is that bitcoin’s price has a fair amount of investment interest attached to it, especially from institutional investors, and including a couple of major players including a sovereign buyer (El Salvador). This means that bitcoin tends to be correlated with major stock indices, with some movement with more “bitcoin-specific” news, such as the recent collapse of FTX. This is because interest in bitcoin currently includes a large speculative element.

Since news about inflation brings the idea that central banks are going to raise interest rates even further, bitcoin currently has a short-term inverse correlation with inflation news. If inflation goes up, the price of bitcoin will tend to go down. Conversely, if inflation “slows down”, such as a favorable reading of the US CPI, asset prices will rise including bitcoin – given that the Federal Reserve and other central banks are slowing interest rate hikes.

2- Bitcoin’s anti-inflation is subtle and the next big event is the halving

The way bitcoin money supply works is more subtle than people give the network credit for. By algorithmically determining the supply of bitcoin (and only allowing the creation of 21 million), bitcoin follows a dramatically different path than monetary policy conducted by sovereign governments and serves as a strong counter-example to loose monetary policy.

Because sovereign governments that control their own currencies have the ability to inflate the money supply, this is what has happened in major developed economies. Putting a digital store of value that has a diminishing money supply and scarcity in the network allows for disinflation – measured on a long enough time scale, bitcoin has achieved remarkable value creation and preservation.

Bitcoin has been through three halving cycles: at the very first, you could buy bitcoin for around $10 USD. After the second, you can buy it for around $500 USD – even the third halving has a price that is consistently below the current price trend, although there have been wild spikes and crashes in the bitcoin price within year-to-year variations.

It is in the halving cycles that bitcoin’s most prominent monetary control mechanism exists. Every 210,000 blocks mined triggers a reduction in the block reward for miners – an exact halving. Right now the block reward for mining a bitcoin block is 6.25 bitcoin and in the next halving it will be 3.125 bitcoin. Bitcoin has a path to be a totally scarce resource by the late 2030s. With this algorithmic money supply and explicit limits on the issuance of new bitcoins, bitcoin is well suited to combat inflationary trends caused by loose money supply in the long term.

3- Disconnect the speculative element with the underlying network activity and scarcity

It is important to consider the speculation and price action separately from the underlying network activity and scarcity generated by the bitcoin network.

An obvious point of contention when it comes to digital money supply is the possibility of many cryptocurrencies to spawn, each purporting to represent some notion of digital value, from ownership of digital art, to governance tokens of a company’s future.

Yet, through the ICO craze, we’ve seen bitcoin persevere and stay strong – bitcoin’s dominance in the markets has fluctuated, but never bottomed out – and many of the tokens that competed for attention and mining before have slowly died by the wayside. In fact, in 2019, about half or more of the ICO tokens were actually dead.

Conversely, activity and use of bitcoin has found a very favorable path. As an example, while nodes on the Lightning Network have recently taken a bit of a hit, the fact remains that while ICOs were dying left and right, the bitcoin protocol was able to push through fundamental changes that enabled a “Layer-2 ” solution that promised fast/low transaction fees worldwide for bitcoin holders. The number of nodes active on the Lightning Network has gone from around 2,000 in January 2019 to around 17,000 in December 2022. The network went from having a network capacity of around $2mn to $85mn.

With the United States and most developed economies (especially Europe) suffering a wave of inflation-related problems, from rising energy prices, to supply chain problems affecting popular goods, the idea of ​​inflation has finally entered the “Western” media sphere. While the reduction in the interest rate target to zero or negative levels after the financial crisis in 2008 was considered to have curbed inflation, this was not entirely true.

Now that inflation has disappeared in countries that are not associated as monetary baskets (such as Turkey, Argentina or Venezuela), the problem has appeared more frequently. Bitcoin, when you unpack it, is a good long-term hedge against monetary inflation, even in the short term, which can be lost in the wave and crash of price action.