Are you brand new to crypto and not sure where to begin to learn about it? Check out my intro to cryptocurrency and intro to blockchain posts or my cryptocurrency archives to learn more about this fascinating new technology!
There are a few things in life that we all have in common, no matter who we are or where we live. Perhaps one of the most important is that we all use some form of money to procure the things that we need in our daily lives. Some of us use credit cards, while others use cold hard cash. Even people currently living under a barter system use the goods they produced themselves as a type of money with which to exchange for someone else’s goods. No matter what type of money we use, we want it to maintain its purchasing power so that we can continue to enjoy the fruits of our labor throughout our lives.
Inflation is the enemy of that hope. Inflation refers to the decline in the purchasing power of money. Inflation can sometimes happen gradually over the course of decades like it has for currencies like the U.S. dollar and the Euro. In extreme cases, inflation can happen over the course of weeks or months, like in Germany after World War I or in Zimbabwe in the 1990s. The root cause of inflation is an increase in the supply of money. Economists will argue that there are a variety of factors that drive an increase in the money supply. However, at its core, the blame for inflation rests primarily with those individuals who are in a position of power over money.
Inflation has infected various types of money for thousands of years. In fact, inflation is so common and has been around for so long that a lot of people erroneously think inflation is natural and that it has to happen in order for economies to function. As a result, societies look for a variety of ways to protect their wealth from the effects of inflation. This usually leads them to invest in inflation hedges, which are assets that typically rise in value (i.e., price) as the money supply increases. Gold, real estate, and stocks are some of the most recognizable types of inflation hedges. However, investments in things like art and fine wine can also be effective hedges. The investments we’ve mentioned, and all inflation hedges that we haven’t, have one thing in common: their supply increases much more slowly than the supply of even the most tightly limited currency. To this group we add Bitcoin, the newest inflation hedge.
Bitcoin: A Quintessential Example of Finite Supply
The attribute of limited supply also applies to Bitcoin, more so than most, which is a large part of the reason why it is commonly referred to as an inflation hedge. Bitcoin’s software code dictates that the total supply of Bitcoin is restricted to 21 million. No more, no less. And that limit is almost assuredly going to remain in place, no matter what.
Perhaps you’re thinking to yourself that software code is rather easy to change. After all, don’t companies like Microsoft, Adobe, and IBM send patches and updates to our computers all the time for their software? They do, but there is one glaring difference between their software code and that of Bitcoin, and it comes down to ownership and control. The majority of the software on your computer was produced and is owned by a centralized software company which retains the right to change the software in any way and at any time.
The same does not apply to Bitcoin. Bitcoin’s code is not owned or controlled by any one person, group, or company. It is controlled by the full community of people using the Bitcoin blockchain. As such, changes to Bitcoin’s code can only be put into effect by getting essentially the entire community to agree to accept the change and then actually carry out the change when the time comes. In the simplest of terms, in order to change Bitcoin’s limit of 21 million tokens and introduce inflation into the system, it would be necessary to convince millions of Bitcoin users around the world to accept inflation. As we discussed above, inflation benefits the few at the expense of everyone else. So how likely is it that millions of Bitcoiners are going to choose to rob themselves so that a few members of the community can benefit?
Bitcoin’s completely inelastic (i.e., unchanging) supply makes it the perfect inflation hedge, all else equal. In a system where nothing else affects Bitcoin’s value other than the supply of the goods or currencies on the other side of a trade, Bitcoin’s value would always go up because the supply of everything else always goes up. More cars are manufactured, more bananas are grown, and more fiat currencies are printed. In the face of it all, Bitcoin’s supply remains exactly the same.
That said, we are all reminded every day that we do not live in a perfect system. There are a variety of competing factors in any market that impact the value of different assets, and the same is also true of Bitcoin. Even so, it is extremely common for critics to claim that Bitcoin is a broken inflation hedge, or not an inflation hedge at all, when its price doesn’t move in a perfectly opposite direction to inflation.
Bitcoin: An Aspirational Inflation Hedge
The last few months have offered us a prime example of Bitcoin’s value being subjected to more than just inflation. For example, the consumer-price index, a proxy commonly used for inflation by a variety of market participants in the United states, grew by 5.4% in June 2021. However, Bitcoin’s price during June 2021 actually dropped by a few percentage points, and that was after it saw a fair amount of upwards and downwards movements throughout the month. Critics have latched onto June 2021’s results to declare that Bitcoin is a failed inflation hedge. Truth be told, if inflation was the only factor currently affecting Bitcoin’s value, they would be right. But even a brief look at the Bitcoin space over the past few months can reveal several of the numerous other factors impacting Bitcoin’s value on a day-to-day basis:
In mid-May, Elon Musk announced that his company, Tesla, would no longer accept Bitcoin in exchange for Tesla vehicles over concerns about Bitcoin’s environmental impact.
In early June, the FBI announced that they had recovered Bitcoin paid to a hacker group in connection with a high profile ransomware attack, leading many onlookers to incorrectly assume that the FBI had hacked Bitcoin’s blockchain.
A little more than a week later, Bitcoin underwent a Death Cross, a bearish market indicator that happened when the short-term moving price average fell below the long-term moving price average.
Throughout the month of June, the Chinese government systematically banned Bitcoin and cryptocurrency mining in most of the country. The resulting drop in Bitcoin’s hash power and mining difficulty was the largest in history.
Each of these events, and countless others over the past several months, has negatively impacted Bitcoin. And as seen by the drop in Bitcoin’s price by nearly half since its all-time high in mid-April 2021, these events have weighed on Bitcoin much more significantly than rising inflation has influenced Bitcoin’s price to move up.
Expecting the value of an inflation hedge to always increase as inflation increases is extremely naïve. And to have that expectation for an asset as new as Bitcoin, which faces far greater headwinds at the current time than mainstay inflation hedges like gold and real estate, is even more so. Bitcoin’s perfectly finite supply makes it the perfect inflation hedge over time, which will be confirmed as more people use it and fewer people fight against it.
Interested in learning more about Bitcoin, Blockchain, and Cryptocurrencies?
The following links are for companies that I personally use and recommend. You are under no obligation to sign up for their services or review their content. However, I may receive some small form of compensation if you do click the links and sign up and that compensation helps support me in my efforts to educate people about cryptocurrency and blockchain:
BlockFi provides cryptocurrency exchange and custody services, interest-bearing cryptocurrency accounts, and more! Open a new account and earn $10 in free Bitcoin when you deposit your first $100 on BlockFi.
Coinbase provides cryptocurrency exchange and custody services, cryptocurrency staking on several blockchains, and more! Open a new account and earn $10 in free Bitcoin when you buy or sell your first $100 on Coinbase.
Nexo provides interest-bearing cryptocurrency accounts, crypto-collateralized loans, and more! Open a new account and earn $10 in free Bitcoin when you deposit your first $100 on Nexo.
Publish0x allows you to earn crypto for reading crypto news and interacting with crypto bloggers, 100% free of charge.
