Crypto

The rich get richer: Rethinking Bitcoin’s power as an inflation hedge

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Image of a gold Bitcoin logo amid a hedge
Image Credits: Boris SV (opens in a new window) / Getty Images

Kay Khemani

Contributor

Kay Khemani is the managing director of Spectre.ai

From turkeys to gasoline, clothes to dollar stores, nearly every avenue of human activity has been hit by the specter of inflation. Across the globe, rising inflation rates are disrupting purchasing plans and spending.

In the face of this inflationary inferno, consumers and institutions holding devaluing fiat currency have sought out alternatives to hedge against. Bitcoin and many other cryptocurrencies are the current weapons of choice, driving the U.S. Securities and Exchange Commission to embrace crypto as an investable asset class.

Bitcoin has witnessed strong year-to-date returns, outshining traditional hedges by rallying over 130% compared to gold’s meager 4%. In addition, increased institutional adoption, sustained appetite for digital assets based on weekly inflows and growing exposure in the media strengthened bitcoin’s case among weary investors.

If these are the moves being made by big money, they must be smart moves. However, while the prospect of hedging against bitcoin may seem enticing to retail investors, certain lingering question marks remain over its viability in mitigating financial risk for individuals.

Miscalculated expectations

The ongoing discussion of bitcoin as an inflation hedge needs to be prefaced with the fact that the currency is often susceptible to market jitters and gyrations: Bitcoin’s value plummeted over 80% during December 2017, by 50% in March 2020 and by another 53% in May 2021.

Bitcoin’s ability to improve user returns and reduce volatility over the long term has yet to be proven. Traditional hedges like gold have demonstrated efficacy in preserving purchasing power during periods of sustained high inflation — take the U.S. during the 1970s as an example — something bitcoin has yet to be tested on. This increased risk, in turn, makes returns subject to the drastic short-term swings that sometimes affect the currency.

Many make the argument for bitcoin based on the fact that it’s designed for a limited supply, which supposedly protects it from devaluation compared to traditional fiat currencies. While this makes sense in theory, bitcoin’s price has been shown to be vulnerable to external influences. Bitcoin “whales” are known for their ability to manipulate prices by selling or buying in large quantities, meaning that bitcoin can be dictated by speculative forces, not solely the money-supply rule.

Another key consideration is regulation: Bitcoin and other cryptocurrencies are still at the mercy of regulators and wildly varying laws across jurisdictions. Anti-competitive laws and shortsighted regulations could significantly hamper the adoption of the underlying technology, potentially depreciating the asset’s price further. All this is to say one thing: It’s far too early to be making judgments on bitcoin being an effective hedge.

Catering to the rich

Against the background of this debate, another salient trend has been driving its momentum. As bitcoin’s popularity grows, it continues to drive adoption and institutionalization of the currency among consumers, including several wealthy individuals and corporations.

A recent survey found that 72% of U.K. financial advisers have briefed their clients about investing in crypto, with nearly half of the advisers saying they believed crypto could be used to diversify portfolios as an uncorrelated asset.

There has also been a great deal of bitcoin advocacy from prolific individuals, known for being technologically progressive, namely billionaire Wall Street investor Paul Tudor, Twitter CEO Jack Dorsey, the Winklevoss twins and Mike Novogratz. Even powerful companies such as Goldman Sachs and Morgan Stanley have expressed their interest in bitcoin as a viable asset.

If this momentum continues, bitcoin’s infamous volatility will gradually dissipate as more and more wealthy people and institutions hold the currency. Ironically, this accrual of value on the network would lead to the concentration of wealth — the antithesis of what bitcoin was created for, subject to the influence of the elite and exclusive 1%.

In line with classical schools of financial thought, this would actually expose retail investors to greater risk, as institutional buying and selling would resemble whale-like market manipulations.

Defying the core ethos

Bitcoin’s growing popularity will no doubt lead to more people owning it, and one can argue that the people with the most money will be the ones who are going to (as usual) end up owning most of it.

This noticeable shift of influence toward ultra-high-net-worth individuals and firms among bitcoin and other crypto circles goes against the very ethos that the Bitcoin white paper was based upon when it described a peer-to-peer electronic cash system.

Among the fundamental rationales for cryptocurrencies is their need to be permissionless and resistant to censorship and control by any given institution.

Now, as the 1% seeks a greater slice of the crypto pie, they boost the prices of these assets in the short term in a way that traditional and less influential retail investors are unable to.

While this move would undoubtedly make a few wealthier, there is an argument to be made that this might leave the market at the mercy of the 1%, contradicting Bitcoin’s intended vision.

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