In recent years, inflation has surged globally, diminishing the purchasing power of fiat currencies. This shift has prompted many investors to seek alternative assets as a protection against inflation, with cryptocurrencies gaining attention as one of these options. Bitcoin, specifically, is often seen as a potential safeguard due to its decentralised structure and the fact that a limited supply of 21 million Bitcoins can be created. Yet, the question of whether cryptocurrencies can reliably shield against inflation remains complicated, given their volatile nature.
In order to be a hedge against inflation an asset needs to protect an investor from the erosion in purchasing power due to rising prices. Traditional inflation hedges, such as gold, real estate and commodities, typically preserve or increase in value when living costs increase. Gold, for example, often rises in value when inflation rises, making it a trusted asset for some during times of financial instability. Bitcoin is often described as “digital gold” since, unlike fiat currencies which central banks can issue in endless quantities, its scarcity makes it a potential defence against inflation. The fixed supply and increasing demand have led many to consider Bitcoin a store of value - much like gold during times of inflation. However, Bitcoin’s volatility presents challenges, making it less reliable than traditional hedges for certain investors - although its growing reputation as a deflationary asset and its decentralised characteristics set it apart in the modern financial world. In addition, the deflationary aspect of Bitcoin is designed through its halving events, which systematically lower the creation of new coins every approximately 15 mins.
Source: TeamBlockchain
This gradual reduction in supply is crucial for Bitcoin's scarcity, strengthening its role as a store of value although, initially, miners were rewarded with 50 BTC per block - but this has since decreased to 3.125 BTC per block as of April 2024. The controlled issuance guarantees that Bitcoin’s maximum supply will never exceed 21 million coins, whereby supporting its deflationary nature. A clear example of Bitcoin acting as a store of value is evident in countries facing hyper-inflation, such as Venezuela. Furthermore, with inflation spiralling out of control, many Venezuelans turned to Bitcoin as a safeguard against the rapid devaluation of the bolivar. The economic turmoil had made the local currency unreliable, prompting people to use Bitcoin to protect their wealth and handle remittances. In 2023, cryptocurrencies made up 9% of remittances to Venezuela, highlighting Bitcoin's role as a dependable store of value during periods of extreme economic instability. Hence, as the country’s financial system deteriorated, Bitcoin became a crucial financial lifeline.
Key comparisons between Bitcoin and traditional inflation hedges, such as gold, focus on their historical performance, reliability and response during crises, such as the COVID-19 pandemic. Gold, with thousands of years of history as a store of value, has demonstrated its reliability as an inflation hedge. Its use in various industries (such as jewellery, electronics and central bank reserves) further establishes its crucial role in the global economy. In addition, during inflationary periods, gold has shown the ability to retain value, unlike many other assets. And, as the Royal Mint has highlighted: “If you had bought £55 worth of gold every month for 18 years from 2002, you would have over £28,000 of gold by 2020. Compare that with putting the same amount into a 3% cash ISA - £15,703.51 - or simply setting it aside with no interest at all - £11,880.” Frequently seen as a digital alternative to conventional assets, Bitcoin was thought to provide stability in times of financial crisis. Historically, many investors have looked to Bitcoin (much like they would gold), believing it could offer protection against inflation and market instability. However, during the early months of the COVID-19 pandemic, Bitcoin’s volatility made it a less reliable hedge compared to the precious metal. And, although Bitcoin had demonstrated a consistent upward trend from 2015 to 2020, its volatility increased dramatically during the pandemic, with prices spiking from $7,149.44 at the close of 2019 to $65,930.54 in 2021. On the other hand, gold, historically viewed as a safe haven during financial crises, did not experience the same volatility as Bitcoin during the pandemic. It also still provided more stability than Bitcoin for investors trying to navigate market volatility during the COVID-19 pandemic - in comparison to Bitcoin, gold’s value remained relatively consistent, underlining its long-standing reputation as a store of value.
The COVID-19 pandemic further revealed a growing link between Bitcoin and traditional financial markets. Whilst Bitcoin was previously somewhat insulated from stock market trends, the pandemic caused its correlation with indices, such as the S&P 500 and Nasdaq, to rise. Moreover, this shift shows that Bitcoin - although a newer asset - is increasingly influenced by broader financial market developments. However, this growing correlation does raise questions about Bitcoin’s effectiveness as a standalone inflation hedge, especially in comparison to gold’s well-established role. Nevertheless, research has demonstrated that Bitcoin has not always maintained its correlation with traditional assets, such as stocks or bonds, but rather provided investors with an alternative option for diversifying risk in the face of market disruptions. And, whilst gold remains a trusted store of value over centuries, the findings from the COVID-19 period suggest that Bitcoin may offer diversification benefits, helping to reduce risks in key stock markets during times of volatility. As the cryptocurrency continues to evolve, it may complement traditional assets such as gold, enhancing portfolio resilience during economic uncertainty; one way to gain managed exposure to gold and Bitcoin is BOLD, which invests in gold and Bitcoin and rebalances very month depending on the volatility of each asset (although others argue: “Gold isn’t a perfect inflation hedge in the short run it is a very good crisis hedge”).
Meanwhile, Raoul Pal, a leading voice in the cryptocurrency sector, believes that digital assets, particularly Bitcoin, can serve as vital hedges against the broader issues threatening the global economy. He argues that excessive debt and the devaluation of currency by central banks are key drivers of wealth erosion for individuals, positioning digital assets as a safer option. In Pal’s view, Bitcoin presents an opportunity to store wealth outside traditional financial structures, potentially combating inflation and economic uncertainty. With such remarks, it could be noted that stablecoins, such as USDC, USDT or DAI, are pegged to fiat currencies and are often considered a hedge against inflation. Whilst they do not increase in value like Bitcoin or gold, stablecoins provide a consistent store of value. This is particularly significant in countries with hyperinflation or unstable banking systems where local currencies experience severe depreciation. A case in point is Zimbabwe and Lebanon, where US dollar-backed stablecoins have become a crucial alternative to local currencies experiencing extreme devaluation. For instance, in Zimbabwe, the inflation rate reached 89.7 sextillion percent (89,700,000,000,000,000,000,000%), leading to the abandonment of the Zimbabwean dollar - in such environments, stablecoins have helped individuals preserve wealth and participate in international trade. Pal’s broader outlook suggests that by 2030, the crypto user base could expand to 4 billion, which could then further amplify stablecoins capability.
Meanwhile, El Salvador’s ambitious plan to make Bitcoin legal tender had a difficult beginning. Despite the government’s attempts to encourage the use of cryptocurrency, problems with the national digital wallet, Chivo, sparked protests and raised concerns about economic instability. Many Salvadorans were sceptical of Bitcoin’s volatility, and surveys showed that most citizens were opposed to its adoption. However, President Bukele insisted that the initiative would promote financial inclusion, enabling quicker remittances and new investment opportunities.
So, whilst economic risks remain, Bitcoin’s potential as an inflation hedge continues to motivate governments exploring its use. Furthermore, in Turkey and Argentina, soaring inflation and currency devaluation have sparked rising interest in cryptocurrencies as alternative stores of value. In Turkey, inflation surged to 50%, whilst Argentina's exceeded 100%, prompting citizens to increasingly use stablecoins such as USDC and Tether to safeguard their savings. The trading volumes in Turkish lira (TRY) have grown significantly, rising from a few million to over $10billion. In 2024, monthly volumes across seven exchanges, covering all trading pairs with TRY as a base or quote asset in USD, showed exceptional resilience to market fluctuations. Moreover, both countries experienced higher-than-average crypto adoption rates (27.1% in Turkey and 23.5% in Argentina), demonstrating their need for more stable financial solutions amidst currency crises. This trend certainly underscores the growing use of cryptocurrencies in emerging markets as a hedge against inflation and economic volatility. Yet, the role of cryptocurrencies as an inflation hedge is not a simple one - it is influenced by the broader economic context. In hyper-inflationary countries such as Venezuela or Zimbabwe, cryptocurrencies offer an alternative to national currencies losing value at a fast pace. The decentralised nature and wealth-preserving potential of cryptocurrencies provide protection against diminishing purchasing power. However, in more stable economies, cryptocurrencies face challenges as long-term inflation hedges; their volatility undermines their ability to act as reliable stores of value, particularly compared to assets such as gold or government bonds.
Hence, can Bitcoin, with its limited supply and decentralised nature, truly serve as a reliable store of value amidst its volatility? How does it compare to traditional hedges such as gold, which has centuries of proven stability during crises and could stablecoins, pegged to fiat currencies, offer a more practical solution for wealth preservation in unstable economies? Finally, as governments and markets grapple with crypto’s potential, is the world prepared for the risks and opportunities that come with relying on digital assets in the face of global economic uncertainty? Diversification remains crucial in any inflation-hedging strategy, so whilst cryptocurrencies might have a role within a broader portfolio, relying exclusively on them would be risky.
This article first appeared in Digital Bytes (29th of October, 2024), a weekly newsletter by Jonny Fry of Team Blockchain.