Is Bitcoin beating inflation?

As inflation rises throughout the developed world and is above the range central banks are comfortable with (around 2-3% guidance per year vs. 6%+ actual) and billions of people suffer as their hard-earned savings are wiped out, 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- Bitcoin BTC is pro-cyclical due to institutional investment, and has a short term inverse relationship with inflation increases – it cannot be said to beat inflation in the short term as a hedge

The first important point to make here is that bitcoin’s price has a fair amount of investment interest in it, especially from institutional investors, and including some major players, including a sovereign buyer (El Salvador). This does mean that bitcoin tends to correlate 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.

As news of inflation brings the idea that central banks will raise interest rate targets even further, bitcoin currently has a short-term inverse correlation with inflation news. If inflation rises, the price of bitcoin will tend to fall. Conversely, if inflation “slows down”, for example a favorable reading of the US consumer price index, asset prices will rise, including bitcoin – in view of the Federal Reserve and other central banks delaying interest rate target increases.

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 determining the supply of bitcoin algorithmically (and only allowing for the creation of 21 million), bitcoin follows a dramatically different path than the monetary policy carried out by sovereign governments and serves as a stark counterexample to loose monetary policy .

Because sovereign governments that control their own currencies have the ability to inflate money supplies, this is what has happened in major developed economies. Setting up a digital store of value that has a reduced monetary 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 gone through three halving cycles: initially 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, even though there have been wild spikes and crashes in the bitcoin price within year-to-year variation.

It is in the halving cycles where bitcoin’s most prominent monetary control mechanism exists. Every 210,000 blocks mined causes a decrease in the block reward for miners – an exact halving. Currently 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 asset by the late 2030s. With this algorithmic monetary 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.

One obvious bone of contention when it comes to digital money supply is the ability for many cryptocurrencies to emerge, each purporting to represent an idea of ​​digital value, from ownership of digital art, to ownership stakes in a company’s future.

Yet, through the ICO craze, we’ve seen bitcoin persevere and remain strong – bitcoin dominance in markets has fluctuated, but the bottom has never gone out – and many of the tokens that previously competed for attention and mining have slowly died on the way. By 2019, about half or more of ICO tokens were actually dead.

Conversely, activity and usage on bitcoin has found a very favorable path. As an example, while nodes on the Lightning Network recently took a bit of a hit, the fact remains that while ICOs are 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 around the world for bitcoin holders. The number of nodes active on the Lightning Network went from around 2,000 in January 2019 to around 17,000 in December 2022. The network went from a network capacity of about $2 million to $85 million.

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

Now that inflation is rare in countries that are not associated as monetary “baskets” (such as Turkey, Argentina or Venezuela), the issue has come up more often. Bitcoin, when you unpack it, is a good long-term hedge against monetary-led inflation, even if short-term, which can be lost in the boom and bust of price action.