Bitcoin's Role as an Inflation Hedge Depends on Location

For many years, inflation was mostly a problem for emerging markets. In these countries, unstable currencies and economic challenges made rising prices a constant worry. However, since the COVID-19 pandemic, inflation has grown into a worldwide concern.

Previously stable economies that enjoyed low inflation rates are now facing increasing prices. This situation has led investors to reconsider how they protect their wealth.

Historically, gold and real estate have been seen as safe havens during inflation. But proponents of Bitcoin argue that its limited supply and decentralized structure enable it to act as a strong defense against inflation. Yet, the effectiveness of Bitcoin as an inflation hedge may rely heavily on where one lives.

Advocates of Bitcoin stress its cap of 21 million coins, viewing this scarcity as a pivotal feature in resisting inflationary monetary practices. Unlike fiat currencies that central banks can produce endlessly, Bitcoin’s supply is controlled by an algorithm, which prevents any artificial inflation. This limited availability is what makes Bitcoin comparable to "digital gold" and potentially a more trustworthy store of value than traditional currency.

Various companies and even national governments have started seeing Bitcoin as a means to mitigate risks associated with fiat currencies and inflation. An example of this is El Salvador, which gained international attention in 2021 for becoming the first nation to recognize Bitcoin as legal tender. The government has been accumulating Bitcoin steadily, and it has since formed an essential part of their economic strategy. Companies like Strategy in the U.S. and Metaplanet in Japan have adopted similar strategies. Additionally, the U.S. is now working to create its own Strategic Bitcoin Reserve.

So Far, Bitcoin Investments Have Been Profitable

Currently, these investment strategies involving Bitcoin have been fruitful, as the cryptocurrency has outperformed the S&P 500 and gold futures since early 2020, in the lead-up to inflation rising in the United States.

Recently, though, Bitcoin's impressive performance has started to show signs of slowing down. Over the last year, it has still been a strong performer, with Bitcoin's gains outstripping consumer inflation. However, economists warn that previous successes do not ensure future results. Some research indicates that the link between cryptocurrency returns and fluctuations in inflation expectations isn’t always consistent.

Returns over the past 12 months. Source: Truflation.

Bitcoin’s Ability as an Inflation Hedge is Uncertain

Unlike traditional assets considered hedges against inflation, like gold, Bitcoin remains a relatively new asset. Its role as a hedge against inflation is still unclear, especially since its widespread adoption has only recently begun.

Even with rising inflation, Bitcoin’s price has been volatile, frequently aligning more with high-risk assets like technology stocks rather than established inflation hedges like gold.

A recent study in the Journal of Economics and Business revealed that Bitcoin’s effectiveness as an inflation hedge has weakened over time, particularly as more institutions have adopted it. In 2022, as U.S. inflation peaked at a 40-year high, Bitcoin's value dropped significantly by more than 60%, while gold remained relatively stable.

Thus, some analysts suggest Bitcoin's market price might be influenced more by investor attitudes and liquidity conditions than by inflation itself. When investment confidence is strong, Bitcoin tends to rise, but it often takes a hit when overall market sentiment is low, dragging it down with stocks.

Authors Harold Rodriguez and Jefferson Colombo, in the same study, noted, "Based on monthly data from August 2010 to January 2023, findings show Bitcoin returns tend to rise significantly after positive inflation shocks, supporting the view of Bitcoin as an inflation hedge." Yet, they observed that the protective value of Bitcoin against inflation was more pronounced in its earlier days, before wider institutional adoption. They concluded that “Bitcoin’s capacity as an inflation hedge is context-specific and likely lessens as it becomes more accepted and integrated into mainstream financial markets.”

U.S. inflation index since 2020. Source: Truflation

Robert Walden, head of trading at Abra, mentioned, "So far, Bitcoin has acted as an inflation hedge, but it isn’t clear-cut. It's more of a cyclical situation.” He added that “for Bitcoin to qualify as a true inflation hedge, its returns would need to consistently exceed inflation year after year. However, because of its irregular tendencies, its performance can vary greatly over time.” Currently, he noted that Bitcoin's movements are more influenced by market behaviors than inflation hedging, focusing strictly on capital flows and interest rates.

Countries Like Argentina and Turkey Seek Financial Stability in Crypto

In nations facing severe inflation and tight capital restrictions, Bitcoin has emerged as a vital resource for safeguarding wealth. Argentina and Turkey serve as prime examples.

Argentina has historically battled high inflation and financial crises. While there have been slight improvements recently, many locals have turned to cryptocurrency as a way to navigate financial limitations and protect their money from losing value.

A recent Coinbase survey found that 87% of Argentinians believe cryptocurrencies and blockchain technology can improve their financial freedom. Meanwhile, around 75% view crypto as a way to combat inflation and high fees for transactions.

Related: Argentina overtakes Brazil in crypto inflows — Chainalysis

With a population of approximately 45 million, Argentina has become a thriving hub for cryptocurrency use, with reports indicating that around five million Argentinians engage with digital assets daily.

Fabio Plein, Director for the Americas at Coinbase, confirmed, "Economic freedom is essential for prosperity, and we are proud to deliver secure and reliable crypto services to Argentina.” He believes that for many in Argentina, cryptocurrency is not just an investment but a necessary tool for reclaiming financial sovereignty.

“There is a lack of trust in the peso among Argentinians; they continuously look for means to preserve value outside of the local currency,” said Julián Colombo, a senior director at Bitso, a primary cryptocurrency exchange in Latin America. “Bitcoin and stablecoins empower them to bypass capital controls and safeguard their savings from devaluation.”

Argentina inflation index. Source: Truflation.

Beyond individual users, businesses in Argentina also employ Bitcoin and stablecoins to maintain revenue and make international payments. Some employees even choose to receive up to part of their salary in cryptocurrency to protect their income against inflation.

Economist and crypto analyst Natalia Motyl remarked, “Currency restrictions and strict capital controls enforced in recent years have made it increasingly challenging to access U.S. dollars in a high-inflation context coupled with a lack of trust in the Argentine peso. In this scenario, cryptocurrencies have served as a powerful alternative for maintaining monetary value, allowing both individuals and businesses to surpass the restrictions of traditional finance.” While the debate over Bitcoin's inflation-hedging capabilities continues, stablecoins appear to offer a more feasible solution in high-inflation environments, particularly those pegged to the U.S. dollar.

Turkey has also become a significant player in stablecoin transactions relative to its economic size. In the year leading up to March 2024, these purchases represented 4.3% of the country's GDP. The boom in digital currencies has been driven by years of double-digit inflation, hitting a peak of 85% in 2022, and a significant decline in the value of the lira over the past five years.

Turkey Shows How Citizens Drive Crypto Adoption

Although Turkey permits citizens to buy and trade cryptocurrencies, using digital currencies for payments has been banned since 2021, when the Central Bank of the Republic of Turkey prohibited any usage of crypto assets in payment and electronic money transfers. Regardless, crypto usage among the Turkish population remains on the rise as more banks provide cryptocurrency services and businesses offer crypto exchange options.

The soaring inflation rates that have led to the lira’s value eroding, increasing by nearly 60% in terms of purchasing power loss due to inflation rising to 85.5% from 2021 to 2023, have compelled many Turkish people to look at Bitcoin as a reliable store of value and medium of exchange.

While some believe that Bitcoin’s scarcity predicts long-term value growth, its volatility and its recent correlation with risky stocks, particularly tech-focused indices like Nasdaq, complicate its effectiveness as a straightforward inflation hedge.

Nevertheless, in inflation-stricken nations like Argentina and Turkey, where local currencies have significantly devalued, Bitcoin has proven to be a vital option for escaping the grip of local currencies, successfully preserving purchasing power in ways traditional money cannot.

Even though Bitcoin remains an emerging asset and more research is needed to understand its full potential as a hedge, one fact is clear—it has largely outperformed consumer inflation up till now. For Bitcoin supporters, this alone is cause for optimism.

This article is intended for informational purposes only and should not be construed as legal or investment advice. The views reflected are solely of the author and do not necessarily reflect the opinions of any particular organization.

Bitcoin, Inflation, Economy