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Is bitcoin being seen as an inflation hedge?

8 Oct 2021 12 day(s) ago

The big financial institutions may be looking at bitcoin to protect themselves against inflation.

When it comes to investment conundrums, there are few tricker ones than bitcoin. The cryptocurrency was intended as a new forms of means of exchange that represented an escape from so called fiat currency – currencies created by government fiat.

After the near collapse of the financial system in 2008, it was thought that something else was needed that is finite. There is only a finite amount of bitcoin, although it can be subdivided endlessly, and that seemed to represent a way out of a corrupted system. It is also ‘trustless’ in that it is based on an algorithm, not a banker or financial operative. That was also seen as a great advantage.

Bitcoin is a long way from being a replacement means of exchange, except on the margins. But it has become a new type of financial asset. A bitcoin is now ‘worth’ over $US55,000 and the total value of all bitcoins is over $1 trillion. The total market cap (value) of all cryptocurrencies is above $2.3 trillion (which is still less than the value of shares in Apple).

Here is bitcoin versus Ethereum:

There is a contradiction here. The values of cryptocurrencies are expressed in fiat currency. This is a bit of a logical problem. Wasn’t it supposed to be an escape from all that?

What is definitely happening, though, is that bitcoin is becoming seen by the big financial institutions as a possible protection against the rampant inflation that seems to be emerging.

Inflation is one way of getting out of the financial mess that the world has got itself in. Global debt is over 320% of global GDP, which is why interest rates are so low. In Australia household debt is over 100% of GDP. Essentially that is unpayable, and has been for a while.

The two ways out of the debt hole, a persistent problem for thousands of years, are typically debt forgiveness -- which may be possible in China’s state controlled banking system but is not in the West’s private banking systems – or inflation, which erodes the absolute value of the debt.

There are indications that bitcoin is now being seen as a hedge against inflation by the big financial institutions that manage about $US100 trillion in assets globally. If that is the case it becomes self reinforcing. Bitcoin is only worth what people think it is worth. If the big institutional managers think it has value as a protection against inflation, then that is what it is worth (how this kind of mass perception, or delusion, is any better than government fiat is not immediately apparent).

JP Morgan has had this to say about it, saying that bitcoin might be better than gold, the traditional inflation hedge that has been used for decades, if not centuries:

“The reemergence of inflation concerns among investors has renewed interest in the usage of bitcoin as an inflation hedge. Bitcoin’s allure as an inflation hedge has perhaps been strengthened by the failure of gold to respond in recent weeks to heightened concerns over inflation, behaving more as a real rate proxy rather than inflation hedge.

“If JPM is correct (this time) and if indeed bitcoin is emerging as not only an accepted inflation hedge - certainly better than gold - but as an asset JPM will push to its institutional clients, especially those sporting a balanced, 60/40 portfolio, the potential inflows into bitcoin and cryptos in general would be remarkable if even a small portion of the global 60/40 portfolio is reallocated toward the digital currency.”

Here are the flows into gold versus bitcoin:

Of course in the high speed financial world, what flows in can just as esily flow out – and very quickly at that. The puzzle of valuing cryptocurrency is far from solved. It it is nothing like a normal currency, where $1 equals $1 -- no more, no less.


Reader note: This is general reporting only and should not be considered in any way to be investment or tax advice. It does not take into consideration the investment objectives, financial situation or particular needs of any particular investor. For more information please read our disclosure statement.


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