Can Bitcoin be an inflation hedge?

Welcome cheapskates to an article that will hopefully be incredibly relevant right now. Economies across the world are still reeling from the Covid pandemic, and the upshot for many, including the US and UK is that inflation is running wild. Just last month, the US reported 6.8% inflation compared to this time last year, with other countries reporting similar. Naturally, this has governments worried, worried to the point where they may have no choice but to raise interest rates to bring inflation back to normal levels (the reason they do this, is because when it’s more expensive to borrow, people and businesses spend less, thus lowering the rate of inflation). This inevitably has an effect on the stock market, with markets across the world already having a dismal December, which is expected to continue into 2022.

If you’re an investor (and presuming you know better than to just sell all. Of your investments), you’re probably thinking if there’s anything you can do to protect against this coming crash right? In times of old, people would move some money over to Gold, which has historically been the gold standard (sorry) for hedges against inflation. But this time, we have a newcomer  – Bitcoin (and other cryptos). In this article, we’re going to cover the viability of this as a hedge and share our strategy of incorporating Bitcoin into our 2022 investing plan.

As always, the following is not financial advice, read our disclaimer

The History of Hedging

To understand if Bitcoin can be an inflation hedge, we need to understand what exactly hedging is and what makes an effective hedge. A ‘hedge’ is essentially an investment in an asset that is intended to counteract a potentially poor performing market or other asset class. in basic terms, if your portfolio of stocks is predicted to fall, you may want to ‘hedge’ this by moving some money into another asset that will go up when your stocks go down.

In a world of rising inflation, there’s two (obvious) assets that could potentially be poor performing over the coming years; that being cash and stocks.

Cash – If you’re a regular reader of ours, you’ll know that we’re not big fans of cash as an asset because even in normal circumstances, cash is a depreciating asset. This means that it loses value year on year – not something we condone here at cheapskate! This is amplified when inflation is running rampant because as prices inflate ever higher, your cash loses ever more value.

Stocks – This ones a little less direct, however when inflation is running wild, governments around the world may look to raise interest rates to stop people and businesses being able to borrow cheap money. This in short slows the economy and in turn, spooks investors who are more likely to pull investments from the stock market.

binance account

So what have people done in the past?

Inflation is nothing new and traditionally investors have turned to assets like GOLD as a hedge against inflation and a potentially bearish market. The reason that gold may hold it’s value during these times is that it is more stable due to its limited supply (you cant easily print more gold or create more gold stocks) so more money in equals higher value as it’s supply stays the same. The problem is, whilst this strategy holds mostly true, gold’s history as a hedge is well….spotted. There have been periods in history where inflation has run wild, but owning gold has also resulted in a loss, yikes.

Like gold, Bitcoin can be viewed as an inflation hedge due to it’s limited supply (there can only ever be 21 million bitcoin). But that’s not the only thing we need to look at when considering Bitcoin as an inflation hedge – we also need to look at it’s correlation to other assets.

Correlation

For an asset to be considered a hedge, it needs to be either weakly correlated, not correlated or even better, negatively correlated against the asset you’re trying to hedge against. If the asset is positively correlated, it is likely to perform similarly to that asset. For example, two different tech stock funds can have a positive correlation because they are both effected by the same things. Even if they contain slightly different stocks, they will often be affected by the same external factors and will likely move in the same direction.

So, when thinking about inflation hedging with Bitcoin, we need to ensure Bitcoin isn’t likely to lose value when cash does and likewise isn’t likely to fall in value in relation to the stock market. Let’s take a look at how these things have performed against each other (we’ve included the NASDAQ, which is the best performing index over the past decade and US dollars as a benchmark):

Last YearLast DecadeAnnualised
Bitcoin310%20,037,142%230%
NASDAQ48%541%20%
USD (vs rest of world)0%4.8%0.5%
USD (due to inflation)-0.35%-19.1%-1.8%

The first thing we can see from the above, that whilst the US dollar fared pretty well against other currencies of the world, it lost 20% of its value over the last decade. In contrast, BTC gained of 20 million times it’s value over the last decade. Although this isn’t concrete proof that it’s an inflation hedge, the evidence suggests that it isn’t correlated to cash. One point for bitcoin.

When we compare against stocks (specifically, the NASDAQ in this scenario), things get a little more complicated. Whilst bitcoin fared far better than the NASDAQ in general, they both increased in value over the past year and over the past decade. On top of that, the only year that the NASDAQ fell (2018), Bitcoin also fell. Does this mean they are correlated then? Well, not necessarily. There are a number of mitigating factors here (like the fact that 2018 featured a global financial crisis), but the fact remains that the data doesn’t yet seem to support bitcoin as the perfect hedge against the stock market. Key takeaway here being YET. Bitcoin is still an emerging asset class, so whilst the data doesn’t yet seem to support, the real test will be if and when the market goes into a bear market. The fact of it is – we just don’t have the data yet.

2022

Which brings us onto 2022, which could very well be the test for bitcoin as a hedge. Bitcoin is currently down to around $48,000 at end of 2021 from it’s high of $69,000. Meanwhile, the stock market at large is still at or near its all time high, looking as though it’s on a knife edge. With a number of factors predicting a rise in bitcoin over the coming year, could Bitcoin be the correct hedge against a stock market crash?

And the answer is…..no one knows. Let down answer I know, but it’s the truth. No matter what ‘experts’ might tell you, no one knows for sure what will happen and if bitcoin can stand up against a flailing market. That doesn’t mean however that you can’t use this information. Here’s some arguments for why bitcoin could be agreat inflation hedge in 2022:

  • It’s a store of value with a limited supply, like gold
  • It’s a way from it’s all time high, unlike the stock market
  • It’s adoption is still growing day by day and isn’t expected to stop
  • Institutional adoption continues to grow
  • A spot ETF seems to be just around the corner in 2022

We can certainly make some educated guesses from this information, so here’s what we plan to do about using Bitcoin as a hedge in 2022 (remember this is our PERSONAL strategy and is intended for inspiration only):

Our hedging strategy for 2022

1.DON’T PANIC

First thing’s first, let’s relearn some basics about a potential crash. Whatever you do, do not panic, and by panic we mean sell all of your assets and turn them all into cash when they start losing value. time and time again, this has proved to be the worst strategy you can have in a stock market downturn, because it’s extremely unlikely that you’ll be able to spot the bottom and buy back in, meaning you’ll likely lose out on gains when the market turns around. Check out our article HERE which goes into more detail on investing during a crash.

2.Don’t be afraid to take some profits

One strategy we have been employing over the last few months is taking some profits on some of the stocks and assets that have made us good returns in 2021 and converting that profit into Bitcoin. It’s key that you review your assets every once in a while to ensure you’re getting the most out of your portfolio. If a stock hits your target price, don’t be afraid to take a profit. This is especially true if you re-evaluate that same stock for the year ahead and it doesn’t have the same potential any more. For example, we recently took profits on LCID (lucid motors) after having the stock in our portfolio for almost a year. after we had doubled our investment, and with a bleak outlook for growth stocks from 2022, we took some profits and bought Bitcoin when bitcoin hit $45K. This goes for other Crypto currencies as well. Seen a 100x return on an obscure currency in 2021? It’s worth thinking long and hard about converting some of that profit into other assets.

3.Think about spreading your existing hedges

Holding a lot of Gold and Silver? If like us, you loaded up on Gold when it was 16% down from it’s all time high ahead of 2022 (at the time, gold made up a whopping 15% of our portfolio, check out our article HERE on investing in gold), it may be worth thinking about spreading this out to other assets like bitcoin. When we hit a profit of around 6% on our gold just last month, we decided to convert some of that gold into bitcoin, to ensure that we’re giving ourselves the best chance of fending off inflation. HEDGE your bets.

4.Get the most out of your Bitcoin

The great thing about crypto in general, is that it is very easy to EARN on your crypto, so even if the entire market drops, you can be safe in the knowledge that your Bitcoin is earning interest to counteract the drop. We personally keep our bitcoin with NEXO (read our review HERE) where we earn 8% PA on top of any potential gain. this mean that even if bitcoin drops 8% in 2022, we will have effectively break even due to the earning potential. Think of it like a buffer.

5.Remember that Bitcoin is different to other Cryptos

If you’re thinking about investing in Bitcoin to hedge against inflation, then you may be tempted to delve into to other crypto currencies to do the same. Whilst this may seem like a good idea (after all, most other cryptos seem to follow bitcoins rise and falls a few weeks later and are positively correlated) tread with caution. As we discussed earlier, we don’t have much data detailing Bitcoin as a hedge, even less so for other crypto currencies. On top of that, one of the reasons people believe bitcoin will be a hedge is due to it’s scarcity and it’s use as a store of value. This is not the case for most other cryptos and some have unlimited supplies. During a crash, it’s entirely possible that we see a divergence between Bitcoin and other crypto currencies.

Next Up…

That’s it folks and thanks for reading! Remember, investing isn’t trading and it’s important to have patience when investing for the long term. If you want to know exactly what we’re investing in every month, sign up to our newsletter below or head on over to our crypto section HERE for more articles like this one!

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