Is Bitcoin A Good Inflation Hedge? Is There a Better Alternative?

During inflationary periods, fiat currencies like the US dollar lose value, causing the cost of consumer goods to rise. 

But have you ever wondered whether bitcoin is affected by inflation?

Bitcoin and other cryptocurrencies are not completely inflation-proof but they aren’t affected by inflation as dramatically as fiat currencies. That’s why bitcoin is popular amongst investors looking for an inflation hedge. 

Let’s discover how inflation affects the bitcoin cryptocurrency, the advantages and disadvantages of bitcoin as an inflation hedge, and if you should invest in it. 

We’ll also explore how you can invest in another smart alternative investment - fine wine with the help of Vinovest.

How Is Bitcoin Affected by Inflation?

Inflation (usually measured by the consumer price index) occurs when the price of products increases, resulting in a decrease of the purchasing power and the value of fiat currencies.

That’s why currencies like the Euro and the US dollar are vulnerable to high inflation rates. 

In contrast, bitcoin and other crypto currencies are less affected by inflation. Although cryptocurrency prices are not 100% inflation-resistant, they have certain features that help minimize the impact of rising inflation on their value.

To discover how bitcoin is affected by inflation, let’s discuss:

• How was Bitcoin created and why?
• Is Bitcoin an inflationary currency?
• What is the connection between crypto and inflation?

1. How Was Bitcoin Created and Why?

After the 2008 recession, many people lost trust in banking institutions. One group named Satoshi Nakamoto drafted a white paper addressing the concerns of the centralized control of money.   

In the white paper, Satoshi Nakamoto presented bitcoin as the first digital currency and a way to transact without using a third party. Instead of relying on third-party banks and other institutions to guarantee the integrity of the network, bitcoin uses a cryptographic blockchain, which serves as a transaction verification system.

In just over a decade since its inception, the bitcoin price went from $0.0008 to more than $20,000. But not all cryptocurrency prices experienced such a meteoric increase.

2. Is Bitcoin An Inflationary Currency?

Each year more bitcoin is mined, making more of it available and subjecting it to a small percentage of inflation. 

However, while a country’s central bank can create an unlimited amount of any fiat currency, bitcoin-mining companies can’t mint as much cryptocurrency as they want. The amount of new bitcoin being mined is automatically reduced by 50% every four years and there’s a finite amount of bitcoin.     

So the level of bitcoin inflation is not as high as fiat currency inflation. 

What about other cryptocurrencies?

Not all crypto is independent from fiat currencies like bitcoin is.

For example, there’s a digital asset called stablecoins. Stablecoins (like Tether and USD Coin) are newer cryptocurrencies, which are attached to fiat currencies like the US dollar. 

They are usually referred to as algorithmic stablecoin because they use an algorithm to maintain a consistent value. 

Since stablecoin is linked to a fiat currency, their value is impacted by inflation, making them high risk assets. 

3. What's the Connection between Bitcoin and Inflation?

Generally, investors view inflation as negative because it reduces a currency’s purchasing power. 

However, while high inflation is a concern, economists warn that extremely low inflation can also be problematic. 

That’s because inflation (in moderate amounts) drives consumer spending, which is necessary for an economy to grow. For example, the United States  Federal Reserve targets an inflation rate of 2%.     

In other words, a healthy currency should have moderate, stable inflation rates. 

Bitcoin is affected by inflation, but has a significantly lower inflation rate than fiat currencies.

Is Bitcoin a Good Hedge Against Inflation? 

Traditionally gold has been considered the best hedge against inflation. However, more investors are turning to alternative investments like bitcoin. 

Although this digital asset isn’t entirely resistant to inflation, it’s considered a reasonable inflation hedge due to its low inflation rate.

Bitcoin inflation is five times lower than the inflation rate of the US dollar. In recent days (May 2022), the inflation rate of the US dollar rose to a record high of 8.6%, whereas bitcoin’s inflation rate is just 1.7%.

Despite the low inflation rate, investing in this crypto asset also comes with risks. Let’s look at both the pros and cons of bitcoin investment.

Bitcoin Investment Advantages

Here’s why crypto enthusiasts are confident that bitcoin is a good hedge against inflation:

1. Limited Supply

The total number of bitcoin that can be mined is finite - supply is fixed at 21 million coins. When an asset has a limited supply like bitcoin, it’s usually a good inflation hedge.

However, newer cryptocurrencies are constantly entering the crypto market to rival bitcoin. Thus, investors could turn to these cryptocurrencies in case of a bitcoin shortage.  

2. Independent of Fiat Currencies and Economies

Like gold, bitcoin doesn’t belong to a single country or entity, nor is it linked to any specific currency. It’s an international crypto asset with global demand. 

Many investors believe that bitcoin is a better option than equities because it’s not influenced or controlled by any government. As a result, it’s not affected by the economic and political risks associated with the stock market. 

3. Easily Transferable

Crypto enthusiasts also boast of bitcoin’s portability. This crypto asset is easily transferable and is even more decentralized than gold - any phone or mobile device can act as a virtual wallet. And due to bitcoin’s decentralized nature, anyone can own and store it.

On the other hand, the supply of assets like gold is controlled by sovereign nations. 

Additionally, bitcoin transactions don't contain any identifying personal information other than the bitcoin addresses and amounts involved.

Bitcoin Investment Disadvantages

Investing in bitcoin is not completely risk-free, here’s why:

1. High Volatility 

Bitcoin is a speculative asset that has unpredictable behavior. 

In January 2022, bitcoin and other crypto, including Ethereum, plunged following the release of the latest consumer price index. In less than 30 minutes, bitcoin declined by more than $1,600, representing a 5% plunge. Bitcoin’s market capitalization fell by more than $30 billion in less than an hour.   

Also, according to an NDR (Ned Davis Research) publication, inflation and interest rates in the US skyrocketed in recent weeks (May-June 2022). This caused Wall Street stocks, including the Dow Jones to plummet. 

A broader market analysis showed that the bitcoin price also plunged almost 50% to under $37,000 a coin around the same time. 

In recent days (as of June 2022), the bitcoin price dropped further to below $30,000. 

This dramatic rise and fall in value makes bitcoin a high risk asset.

2. Unpredictable Future Performance

Bitcoin (and crypto as a whole) is too young of an investment class to know for sure whether it's a good inflation hedge. 

The risks involved in bitcoin investment are less understood than those associated with other assets such as stocks and bonds, making it a speculative asset. Given bitcoin’s brief history, it’s too early to predict its performance in the future. 

3. Unregulated and Risky

Many investors also view bitcoin and other crypto as risky assets because they aren’t backed by anything (US dollars are backed by the Federal Reserve.) Crypto and bitcoin in particular, are not underpinned by an intrinsic value (they’re not attached to anything tangible.) 

These assets are also largely unregulated, and since transactions don’t require identifying personal information, they can be used for illegal transactions such as money laundering. 

Should You Invest in Bitcoin?

Unlike the stock market that opens and closes daily, bitcoin is conveniently accessible to buy, sell, and trade any time of day, every day of the week. 

The increasing attendance at the annual Bitcoin 2022 Conference proves that the popularity of this form of crypto is continuously growing. Some retail investors see bitcoin as a way to diversify their portfolio since it’s uncorrelated to stocks. 

But experts also warn that since bitcoin is a high risk asset, it’s best to have a lower portfolio allocation to minimize exposure to portfolio losses. Randy Frederick of Schwab Center for Financial Research suggests allocating no more than 1% of your portfolio to crypto assets.   

Retail investors willing to take a risk on bitcoin should avoid being influenced by the hype surrounding cryptocurrency. Instead, you should adopt a solid investment strategy. 

Also, keep in mind that since December 2020, digital currency has undergone a series of drastic ups and downs, making it an unpredictable investment.

And before you invest, ensure you use only reputable crypto companies.

If you prefer to invest in more stable, less risky assets, why not consider fine wine investment?

Investing in Fine Wine: A Savvy Inflation-Proof Alternative to Bitcoin

In contrast to the crypto market, the fine wine market continued to expand even during the 2008 recession, the market turmoil caused by the 2020 pandemic, and the rising inflation rates in 2022. 

During the initial high-inflation months of 2022, fine wine sales increased steadily by 24.7%, making it a less riskier asset than bitcoin.

The wine market also enjoys positive returns (usually between 6% and 15% long term), largely due to the imbalance between demand and supply.

From all the wine produced globally, only 1% is investment-worthy, making it hard to find an outstanding bottle. Additionally, its supply decreases gradually as the finest vintages are sold and consumed. 

Moreover, fine wines are known to improve as they age, which increases their demand and price further.

Ready to invest in fine wine? Vinovest can help!

Vinovest is an expert wine investment company that helps you buy, store, and sell rare and authentic wines from around the globe in just a few clicks. 

Here’s how the platform works:

• Sign up.
• Complete a short questionnaire to help determine your preferred investment approach.
• Fund your account with at least $1,000.
• Vinovest’s AI will curate the best investment recommendations for you based on your completed questionnaire.
• Watch your portfolio grow.

Vinovest’s master sommeliers can help you source, store, and sell fine wine bottles from France, the United States, or any other wine region.