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Is Bitcoin really an inflation hedge?

Recent price action across major cryptocurrencies, including Bitcoin and Ethereum, is putting that theory into question. Since early November, these crypto bellwethers have each fallen by more than 30%.

At the same time, inflation has climbed to its highest level in nearly 40 years. Bitcoin is often referred to as an inflation hedge because of its fixed supply and above average annual returns. However, crypto’s volatility, nascent history and undefined future may be at odds with this simplistic view.

Chart titled Crypto Crash tracks Bitcoin and Ethereum’s price from July 2021 through January 2022. Both generally track together, peaking on November 8, 2021 (Bitcoin at $67,500 and Ethereum at $4,812) and dropping since then to $42,592 (Bitcoin) and $3,248 (Ethereum) in January 2022. Source: Ally Invest, Yahoo Finance
Inflationary Pressure

The crypto slide started in November when inflation readings reached levels not seen since the ‘90s. On November 8, two days before October inflation was reported, Bitcoin reached its most recent peak of $67,500 (on a closing basis). By that time, inflation, as measured by Consumer Price Index (CPI), was running above 5% for more than five months. Cryptocurrencies weren’t around the last time inflation was above 5% and many crypto investors might not have been either.

At 7%, CPI is running hot to say the least. Yet crypto’s decline has continued.

There is some merit to the idea that Bitcoin could be a hedge against inflation. Having fixed supply makes it like gold, a traditional inflation hedge. It’s similarly priced in dollars. It’s not a surprise that the correlation between Bitcoin and inflation is strong. But the history of crypto’s relationship with inflation has been limited. It doesn’t include the ‘70s and ‘80s when double digit inflation was common. Gold earned its title of inflation hedge then.

Finding Footing

Bitcoin and other cryptocurrencies have become famous for their big price swings. That type of action can make the asset class less reliable as a hedge. While Bitcoin has been around since 2009, crypto is in the early stages of adoption by consumers, retailers and the financial system. That can be exciting in the long-term but can add to volatility near-term.

Plus, unknown risks are not a typical characteristic of safe havens in inflationary environments. And crypto has plenty. Not the least of which is global regulatory uncertainty.

The S&P 500 is sometimes cited as a hedge of inflation because its average annual return has steadily outpaced inflation in the past. Bitcoin was actually correlated to the performance of the S&P 500 over the past 5 years, but that relationship broke down recently as Bitcoin has increased in popularity and its volatility has outpaced the index.

The Bottom Line

While the weakness in crypto over the past couple months may not be completely related to the rise in inflation, it seems as though that may be a contributing factor in the recent slide. Right now, crypto isn’t living up to the inflation hedge hype.

There are still plenty of reasons to educate yourself about cryptocurrencies and maybe even dip your toes into the water with a Bitcoin ETF or a stock that participates in the development of the blockchain ecosystem.

The latest move in Bitcoin should be viewed as a reminder that the market for crypto is volatile in both directions.

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Headshot of Lindsey BellLindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.

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