Here’s Why Bitcoin May Not Be the Best Hedge Against Inflation

  • Bitcoin (BTC-USD) prices continue to decline from their highs in 2021.
  • Cryptos like Bitcoin are considered to be a good hedge against inflation but evidence shows otherwise.
  • Bitcoin will face short-term headwinds but I give it a hold rating for long-term gains.
A blue-toned concept image showing Bitcoin (BTC) cracking in half.
Source: Shutterstock

Once seen as a thriving investment class, cryptocurrencies like Bitcoin (BTC-USD) have seen a sharp fall in prices in recent months. After skyrocketing to an all-time high of $64,000 in mid-2021, Bitcoin has ping-ponged in the $40,000 range this year. While there is no singular event that has contributed to its decline, several factors, including higher inflation, rising interest rates and the negative impacts of Bitcoin mining, are to blame.

Bitcoin bears have good reasons for their inhibitions towards this asset class and it is unlikely we see upward trends in the likes of those in 2020 and 2021. Bitcoin was up 300% in a pandemic-ravaged 2020–an impossible feat in today’s market.

But that’s not to say that Bitcoin is a bad investment. The decentralized nature and security this crypto offers are good reasons to remain confident in its long-term potential. With that said, it’s worth waiting for the markets to cool down before investing in BTC.

BTC-USD Bitcoin $40,195.08

What’s the situation with Bitcoin?

Bitcoin prices have pushed higher in the last week, but cryptocurrencies continue to face pressure from several macroeconomic trends. One key aspect of this is a return to post-pandemic normalcy. As the effects of the Covid-19 wind down, people are spending less time trading online which has inevitably led to a slowdown in the growth of the cryptos.

Another overarching factor is the Fed’s monetary policy, which will be a headwind for financial markets. The Fed’s move to increase interest rates to combat rising inflation will increase the cost of borrowing. As a result, investors will become less risk-averse and shy away from inherently speculative and volatile assets like Bitcoin. With the markets bracing for a volatile summer and an impending recession, the optics for Bitcoin’s short-term growth are not looking too good.

A third and broader reason for Bitcoin’s decline is the impact of mining on the environment. The security associated with BTC-USD comes with running specialized hardware (aka mining) which consumes a lot of energy. And while miners have explored more eco-friendly alternatives, there are still several strides to be made in the space.

The recent fall in Bitcoin prices is the result of several macroeconomic changes and a reversal of fortunes in the near term is unlikely.

Inflation and Bitcoin

The impact of the Fed raising interest rates in an effort to curb inflation is now a major area of focus. Hence, it is worth considering the role of Bitcoin in today’s market environment. During a period of inflation, investors look for ways to hedge their declining purchasing power. Traditionally, real estate and gold have served as good ways to do this, but investors are now looking at specialized asset classes like crypto as a hedge.

In an ideal world, Bitcoin should serve as an effective hedge against inflation given its exclusivity but this has not proven to be the case. BTC-USD prices have fluctuated wildly so far this year, alluding to the fact that the currency remains a speculative asset. Uncertainty in the markets has led Bitcoin to trade in tandem with risky assets like tech stocks and not independently as one would expect.

Another argument against Bitcoin’s viability as an inflationary hedge is its inverse relationship with gold. The correlation between BTC and gold is at an all-time low since 2018 at -0.4. This certainly does not help Bitcoin’s case given that gold has served as a safe hedge against inflation for many years. On the flip side, Bitcoin’s correlation with traditional investments like stocks and bonds is on the rise. This further diminishes the notion that the crypto is a good inflationary hedge.

Investing in Bitcoin is not the best way to balance out your portfolio in today’s volatile market but its long-term potential remains strong. As cryptos continue to gain more stability, they will eventually serve as a good hedge against inflation.

Final Verdict on Bitcoin

There’s no denying the use-cases for Bitcoin. Cryptocurrencies are decentralized and have the ability to overcome challenges that have plagued traditional financial institutions. Adding to this, BTC-USD is also likened to digital gold, hinting that it could become a legitimate store of value one day.

However, rising inflation coupled with regulatory issues and the negative environmental impact of mining have dampened Bitcoin’s growth. Considering both the long and short-term perspectives, I think it’s worth holding on to Bitcoin for its long-term gains, but I would wait for the crypto to stabilize before putting more money behind this name.

On the date of publication, Divya Premkumar held a long position in BTC-USD stock. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines.

Divya Premkumar has a finance degree from the University of Houston, Texas. She is a financial writer and analyst who has written stories on various financial topics from investing to personal finance. Divya has been writing for Investor Place since 2020.

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