Is Bitcoin still safe from inflation? BTC Market Correlation
Cryptocurrencies are increasingly dependent on the macroeconomic environment of which they inevitably become a part. Unfortunately, current inflation rates in the US, Europe and many other countries around the world make this environment hardly encouraging for investment. However, causing investors to flee inflation, and the specter of recession, rising consumer prices and loss of purchasing power due to fiat.
For years there has been a strong narrative describing Bitcoin (BTC) as one of the best hedges against inflation. The parabolic rise of cryptocurrencies combined with the increasingly weakened purchasing power of fiat currencies only fueled this interpretation. However, the strength of the argument of proponents of the oldest and largest cryptocurrency has weakened in the path of the year-long bear market.
Can the thesis that Bitcoin is an inflation hedge still be defended in 2022? Does the correlation with traditional markets and tech markets make us treat BTC as another risky asset? Or should we return to the narrative of the previous bull market that Bitcoin is digital gold and the safe haven of blockchain technology?
Bitcoin is a hedge against inflation – why such a promise?
Why should Bitcoin even be considered a hedge against inflation? There are at least two groups of arguments that are used to justify this thesis.
The first concerns the basic characteristics of Bitcoin. Unlike fiat currencies, BTC has a very transparent monetary policy that does not depend on any individual entities, commissions or central banks. Bitcoin cannot be “printed” as its total supply is cryptographically fixed at 21 million BTC.
Subsequently, Bitcoin’s inflation rate – yes, BTC is not deflationary, as some believe – remains at a stable low level. It currently stands at around 1.8% per year. These levels are predetermined and cannot be changed. Also, Bitcoin’s inflation rate drops every four years or so with successive halvings. Each such event, of which there have been 3 so far in Bitcoin’s 13-year history, halves the inflation rate.
No institution, individual miner or BTC whale not only has the power to change this, but also has no interest in a potential change. Bitcoin’s monetary policy is doubly protected: by cryptographic (blockchain) and energy (Proof-of-Work protocol) security.
The second group of arguments for the thesis that Bitcoin is a hedge against inflation concerns its long-term results as a trading object. There are precise calculations that say that no one who bought BTC at any point and held it for exactly 3 years, 4 months and 4 days is at a loss.
Even a glance at BTC’s trading history makes it easy to determine that the long-term trend is simply up. Despite brutal bear markets that brought the price of BTC down 86% in 2014, 84% in 2018 and 75% in 2022, Bitcoin has the character of a Phoenix reborn from the ashes. Except that it is always reborn stronger, and the level of increases in subsequent bull markets is best expressed on a logarithmic scale.
BTC weaker than avocado
Despite the above arguments and the well-known history of BTC trading, the inflation hedge hypothesis is once again being questioned today. The reason is the brutal bear market that has been going on since the end of 2021 and through 2022. It has pushed the BTC price 75% below the all-time high (ATH). Bitcoin has fallen from the 69,000 level reached in November 2021 to the current low of $17,600 in June 2022.
It’s hardly surprising that some investors – who bought cryptocurrencies at the high end of last year’s bull market – would have happily opted for inflation in their fiat money. This is currently 8.2% in the US and 10.7% in Europe. Even such high numbers are more favorable than a 74% drop:
Some Twitter users are wondering about the inflation hedge story by juxtaposing Bitcoin with various assets and commodities. For example, @MacroAIf____ compared BTC to avocados, claiming that “avocados are still a better inflation hedge than Bitcoin.”
Correlation with traditional markets
So why – despite all the fundamental and technical advantages – is Bitcoin losing ground to avocados in recent months? One reason is the strong positive correlation between cryptocurrencies and traditional markets, especially technology indices. Bitcoin supporters are not at all happy about this, as there have been attempts in the past to view BTC as an asset that is not correlated with the SPX or NASDAQ.
However, 2022 has brought about a number of changes. During the past year, a very strong positive correlation has formed with the hemorrhaging stock market. Such a strong long-term combination of cryptocurrency and traditional stock markets has not been recorded before.
In the chart below we see the daily correlation coefficient between Bitcoin versus NASDAQ (blue) and SPX (blue). It has been almost exclusively positive and very high since the beginning of 2022 (yellow area). The correlation with the NASDAQ index of technology companies has remained at 80-90% for most of the year, and with the SPX index at around 70-80%.
Moreover, the correlation with the traditional market is particularly evident during periods of macroeconomic data releases. In particular, these include new data on the level of inflation, unemployment or Fed conferences on interest rate hikes.
This was recently pointed out by the user @VetleLunde, who tweeted October 2022 data on Bitcoin’s correlation with NASDAQ, SPX, gold and DXY. Based on them, he concluded that the markets are more correlated during US trading hours and the publication of inflation data (October 13). Thus, we see that American investors currently see Bitcoin more as another risk asset than as a hedge against inflation.
Negative correlation with dollar
One consequence of viewing Bitcoin in a similar way to technology stocks is the negative correlation with the US Dollar Index (DXY). In fact, if one compares the long-term charts of BTC and DXY, the inverse relationship is obvious.
All Bitcoin bull markets (green at the top) correlate with declines in the dollar index (red at the bottom). Conversely, BTC bear markets coincide with DXY gains. In addition, the strong inverse relationship is confirmed by the correlation coefficient at the bottom of the diagram. In all periods with strong trends, the correlation was almost exclusively negative (grey areas).
Conclusion: Inflation is a hedge against BTC
Many on-chain indicators show that the fundamentals of the Bitcoin network are as strong as ever. Also, the global adoption of cryptocurrencies is accelerating, with institutional investors becoming dominant players, driving the price of BTC.
However, blockchain technology’s entry into the mainstream comes at a price. It is the acceptance of Bitcoin becoming part of global finance, and the influencing factors may be different than Satoshi Nakamoto originally envisioned. Therefore, a strong correlation with traditional markets or the perception of BTC as a high-risk asset is not something undesirable.
This is another stage of cryptocurrencies entering maturity. Over time, the level of volatility that is so characteristic of cryptocurrencies and tempting for traders will weaken. The bottoms will not be that low, and the tops will not necessarily be reached in the traders’ parabolic euphoria.
Another impressive feature of Bitcoin is its adaptability and ability to fit into different, often mutually exclusive narratives. Bitcoin is not “just” a hedge against inflation, “just” digital gold, or “just” another risky asset. Bitcoin has ignited a new, previously unknown class of digital assets, the Cambrian explosion that we are now experiencing.
The goal of this rapid digital evolution of money is to improve the flawed mechanisms based on the “thin air” of fiat currencies. And while it sometimes feels like “inflation is a hedge against Bitcoin”, we mustn’t see the forest for the trees. And Bitcoin’s forest is just emerging.
For BeInCrypto’s latest Bitcoin (BTC) analysis, click here.
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