One of the main attractions and talking points for converting non-believing crypto into believing was its perceived ability to be a great inflation hedge. This belief is not broken.
The underlying argument was that since bitcoin is a finite currency in the midst of growing demand, it has the characteristics required to be inflation proof. Crypto enthusiasts also point to the fact that the currency is decentralized without any central bank manipulation or control as a major factor that differentiates it from fiat currency such as the US dollar.
These beliefs and the foundations for which they are held have crumbled in recent weeks as the rate of inflation gallops to highs not seen in more than a decade. The cascading effect is a cryptocurrency crash that has seen blockchain-built flagship bitcoin lose nearly 60% in value since the start of the year. As we set this article for publication, Bitcoin is struggling to hold at $20,000. This begs the question: why are bitcoin prices collapsing when they should remain firm during inflation?
The answer is simple, the value of bitcoin is represented by what it sought to replace, a fiat currency. The value of bitcoin is often translated into US dollars, and as such, anything that happens to that currency (like inflation) will negatively affect bitcoin. It’s a simple logic that crypto enthusiasts seem to have missed.
Another reason why bitcoins and other altcoins fail the inflation test is because investors who have held on to the assets are selling off en masse due to the latest interest rate hike put in place by western governments. As the US, UK and most Western countries are experiencing high rates of inflation at breakneck speed, their central banks have raised interest rates so aggressively that they are forcing investors who took out margin loans to invest in crypto assets to sell those assets to hedge their positions. This created a ripple effect pushed by more sellers than buyers giving in to simple economic law. Whenever there are more sellers than buyers, prices go down.
Finally, cryptocurrencies only remain a hedge against inflation if they are used as currencies and not as assets of a store of value like gold. Ultimately, it fails the test as a store of value because it is a highly liquid asset backed by many short-term funds.
Its value is also not intrinsic and, as Bill Gates rightly mentions, it is traded on the basis of the biggest fool theory. Cryptocurrency investors do not buy them because they see them as a store of value or wealth. They buy it because they believe the price will continue to rise and then they can turn around and sell the same asset to someone else who then hopes another person will like to buy.
Cryptocurrencies like bitcoin will only be a hedge against inflation, it is used as currency and most buyers own them because they view them as a store of value not a commodity, they wish to trade on the basis of the biggest fool theory. Therefore, bitcoins must be less volatile in price appreciation and less of a “commodity” if they are to be an excellent inflation hedge.