One of the major attractions and talking points for converting a crypto non-believer to a believer was its perceived ability to be a great hedge against inflation. That belief is not shattered.
The underpinning argument was that bitcoins being a currency in limited supply amidst rising demand, it has the characteristics required to be inflation-proof. Crypto enthusiasts also point to the fact that the currency is decentralized without any central bank manipulation or control as a major factor that makes it different from fiat currency such as the US dollar.
These beliefs and the foundations for which they have come to be appreciated have come crashing down in recent weeks as the inflation rate gallops to records not seen in over a decade. The cascading effect is a cryptocurrency crash that has seen the flagship blockchain-built bitcoin lose almost 60% in value year to date. As we place this article for publishing Bitcoin is struggling to hold at $20k. This begs the question, why are bitcoin prices crashing when they should be holding firm during inflation?
The answer is simple, bitcoin’s value is represented by what it sought to replace, a fiat currency. The value of bitcoin is often translated into US dollars and as such whatever happens to that currency (such as inflation) will negatively affect bitcoin. It is simple logic that crypto enthusiast seems to have missed out on.
Another reason why bitcoins and other altcoins are failing the inflation test is that investors who held on to the assets are selling in droves due to the latest interest rate hike implemented by western governments. Like the US, the UK, and most of the western world experience break-speed high inflation rates, their central banks have increased interest rates so aggressively it is forcing investors who took margin loans to invest in crypto assets to sell those assets to cover their positions. This has created a ripple effect driven by more sellers than buyers caving into a simple economic law. Whenever there are more sellers than buyers, prices will drop.
Finally, cryptocurrencies remain a hedge against inflation only if they are used as currencies and not assets of a store of value like gold. It ultimately fails the test as a store of value because it is a highly liquid asset that is supported by a lot of short-term funds.
Its value is also not intrinsic and as Bill Gates rightly mention, it is traded on the basis of the greater fool theory. Investors in cryptocurrencies do not buy them because they see them as a store of value or wealth. They buy it because they believe the price will keep rising and then they can turn around and sell the same asset to someone else who then hopes another person will like to buy.
Cryptocurrencies like Bitcoin will only be a hedge against inflation, it is used as a currency and most of the buyers own them because they see them as a store of value and not a commodity, they wish to trade on the basis of the greater fool theory. Therefore bitcoins need to be less volatile in price appreciation and less of a “commodity” if it is to be a great hedge against inflation.