Can Bitcoin be a hedge against inflation?

1.Why do you need a hedge against inflation?

How effective is a bitcoin hedge against inflation? First, let's understand what inflation is and other instruments that can hedge against it.

With inflation in fiat currency-based economies, experts and even the general public are looking for an investment vehicle or instrument that can hedge against inflation. Gold, stocks and real estate have long given respite to investors who fear devaluation due to inflation. One might argue that these commodities have always had their limitations as a hedge.

Recently, however, commodities such as gold bullion or gold and silver have seemed less reliable in a smaller investment context. 2021 has seen a steady decline in the price of gold. Real estate is illiquid, has high transaction costs, and requires ongoing management and maintenance. As for stocks, they require investors with sophisticated financial skills, and most ordinary people lack the skills to be an effective stock manager.

2.A way to hedge against inflation

Putting money into store-of-value investments such as gold, real estate, stocks and cryptocurrencies can help curb inflation.

Over time, cash loses its purchasing power and holding it causes people to lose their savings. This has prompted people to spend their money on value investments like gold, real estate, stocks, and now cryptocurrencies. Since then, the ability of bitcoin to withstand inflation has become a question to consider.

An asset held to preserve its value should be able to maintain its purchasing power over time. In other words, it should appreciate in value, or at least remain stable. The key attributes associated with such an asset are scarcity, accessibility and durability.

Gold as a hedge against inflation

Gold has had a mixed track record in past inflationary periods. In the 1980s, holding gold sometimes generated negative returns for holders.

Morningstar's data gives us a glimpse into how gold has performed mixed during past inflationary periods. When consumer prices rise, a commodity that is considered a hedge against inflation is expected to rise as well. During periods of high inflation, particularly in the 1980s, gold holders sometimes ended up with negative returns.

In recent years, gold has gradually lost its luster as a hedge. Interest in gold waned during the epidemic, and even after it subsided. In the long term, gold is still seen as an investment worth holding, but in the short term, it may not be as reliable.

Real Estate as a Hedge Against Inflation

The bursting of the U.S. housing bubble highlights that real estate is not always available as a hedge against inflation.

Real estate has long been seen as an effective hedge against inflation. However, this myth was burst in the U.S. housing bubble, where home sales and prices suffered a sharp decline in March 2007. According to the National Association of Realtors (NAR), home sales fell 13 percent to 482,000 units from a peak of 554,000 units in March 2006.

In the U.S. and around the world, real estate prices are closely tied to government policy, national political and economic stability, local population and economy, geographic location and infrastructure, and other factors. There are too many parameters for the average person to understand.

Stocks as a hedge against inflation

Long-term investments in stocks help to overcome the effects of inflation. Just make sure the company has strong fundamentals.

Some stocks do help protect the value of your investment. Even if these stocks take a beating from impatient investors in the short term, they will recover well over time. But you need to take into account that not all stocks are good hedges against inflation. You need to find companies with strong fundamentals that are more likely to deliver better dividends to shareholders.

What they have in common: Gold, real estate and equities are all tied to central entities

Traditional asset classes are controlled by central governments, which makes them susceptible to bias and pressure.

The value proposition of all traditional asset classes has always been tied to the policies of central governments or institutions such as federal banks. An asset is inherently tied to a system such that the asset holder cannot intervene, which is not a truly reliable hedge because the central agency has control over the entire process at the push of a button.

3.Is Bitcoin a good inflation hedge?

Bitcoin is an effective inflation hedge due to limited supply and decentralization. These factors bring scarcity and resilience.

The two main factors you need to consider when looking at "can bitcoin prevent inflation" are limited supply and decentralization.

Limited Supply - Bringing Scarcity

The supply of Bitcoin (BTC) has been algorithmically limited to 21 million pieces. At the end of 2021, 18.77 million Bitcoins have entered circulation. In other words, 83% of the possible bitcoins were mined within 12 years of the birth of this cryptocurrency.

Inflation occurs when countries or central banks continue to overprint paper money, resulting in an oversupply of money. Economic theory states that inflation occurs when the supply of money grows faster than the actual output of goods or services. This is because households now have more cash to buy the same amount of goods, causing prices to rise.

A pre-set limit on the circulation of bitcoin means that there will not be an oversupply, thus controlling inflation. In addition, the annual extraction rate of this digital currency decreases by 50% approximately every four years. Given the current supply schedule, the annual production rate of Bitcoin will be about half that of gold and will continue to decline, making it scarcer than gold and pushing up its value.

Decentralization - Increased Resilience

Bitcoin's decentralized structure removes it from the control of a central authority. With thousands of nodes operating globally, the Bitcoin network is best able to withstand external attacks that might attempt to change its monetary policy and avoid undermining the inherent scarcity of the digital currency. When it comes to the degree of decentralization, there is no other currency that can match Bitcoin.

In any authority or organization, coercion occurs through pressure or bribery. Bitcoin, however, is not subject to these factors because there is no leader to influence and no executive board to bribe. Since the inception of Bitcoin, its founder Satoshi Nakamoto has used a pseudonym. Bitcoin remains a unique digital asset because it has a super successful track record in the absence of influential leaders.

Anyone can run a bitcoin node, verify transaction history, and forward transactions through the network. The extensive decentralization means that cryptocurrencies cannot be reused. It also helps distribute tokens and has helped Bitcoin through many challenges. It helps Bitcoin prevent centralized control of information and enables all Bitcoin holders to participate in decision-making.

When companies interested in Bitcoin tried to change the block size to allow more transactions per block, individual node operators and developers strongly opposed the proposal. This highlights the inherent resilience of Bitcoin, as economically powerful entities have failed to impose their will on the Bitcoin network.

4.Can Bitcoin be a hedge against inflation?

Statistics show that bitcoin is very effective at fighting inflation and is much better than assets like gold, real estate and stocks.

As an asset, Bitcoin does surprisingly well and far better than inflation, although you should be careful about external factors such as the regulatory environment. Statistics show that bitcoin is more likely to retain or increase in value than assets such as gold, real estate, and stocks.

In summary, potential advantages such as limited supply and decentralization drive Bitcoin as a unique asset that can be a hedge against inflation.