After decades of low inflation, investors and consumers are fretting about increasing prices again. There has been a culmination of factors that could push inflation past target levels in several countries this year.
Could Bitcoin live up to its potential as a safe store of value and protect users from the impact of higher inflation?
Some experts believe it could. Here’s a closer look.
On a fundamental level, the prices of all goods and services are determined by supply-demand dynamics. In 2020, the global lockdown and travel restrictions compressed demand, while supply remained elevated. This led to a drop in inflation.
However, in 2021, economists expect consumers to unleash pent-up demand as the economy reopens. Suppliers that have gone bankrupt or wound down operations could struggle to meet this surge in demand during the latter half of the year.
Perhaps the most noteworthy factor in 2021 is the supply of currency. Governments across the world have printed more currency to deliver pandemic benefits, economic relief and bolster their health systems in response to the crisis. As the supply of currency hits a historic level, economists believe their value could depreciate causing inflation.
Higher-than-expected inflation reduces the value of traditional assets. The cash flow from stocks and bonds could be worth less if inflation creeps up. Gold and real estate usually have a positive correlation with the rate of inflation, which is why investors use these asset classes as hedges to protect their wealth.
However, many people think Bitcoin could prove to be a better hedge against inflation than many other traditional asset classes.
Like gold, Bitcoin is untethered to the rest of the economy. Unemployment, political crises and economic output do not change the nature of an ounce of gold or a unit of BTC. In fact, the depreciation in the U.S. dollar could actually make both gold and Bitcoin more valuable. This is why both are considered effective hedges against inflation.
Academics warn that it’s too early to judge Bitcoin’s potential as an inflation hedge. However, the asset has been soaring in recent months even as Wall Street’s expectations of inflation rise, which could be an early indication that Bitcoin could offer this protection. A growing number of analysts and professional investors have claimed that Bitcoin should theoretically be detached from the economy and, thus, inflation pressure.
Source: St. Louis Fed
If the digital asset lives up to expectations in the next inflationary cycle, more investors could count on it for wealth protection in the future.
Inflation hedge could be an important use-case for Bitcoin in the years ahead as government stimulus programs and pent-up demand potentially cause prices to rise. Institutional investors and hedge funds have already started allocating part of their portfolio to this asset class.