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Last week, inflation data for the month of January was reported for the United States: The U.S. dollar lost 7.5% of its purchasing power compared to one year earlier, the biggest drop in 40 years. While this is not a good situation for the U.S. economy, one might have predicted this would be a moment of vindication for bitcoin holders. But it’s not panning out that way.
Since inflation really started to tick up in the spring of 2021, bitcoin has lost 18% of its value relative to the dollar, underperforming other risk assets like the S&P 500 stock index (up 8%) and traditional inflation hedges like gold (up 7%). Both bitcoin and the Standard & Poor’s 500 stock index are down 8% so far in 2022, while gold has rallied 3%.
Jill Gunter, a CoinDesk columnist, is co-founder of the Open Money Initiative, a non-profit research organization working to guarantee the right to a free and open financial system. She is also an investor in early-stage startups with Slow Ventures.
Bitcoin, despite its fixed supply and the popular “store of value” thesis, continues to trade with high volatility and tighter correlation with relatively risky assets like stocks versus traditional safe havens like gold. It is not inflation per se driving this price action, though. It is the U.S. Federal Reserve’s signaled response to inflation: hiking interest rates over the course of this year to mop up some of the excess liquidity in the economy, strengthen the dollar once more, and get inflation under control.
The market’s movements and the backdrop of interest rate increases is reminiscent of the last quarter of 2018, the last time the Federal Reserve went through a hiking cycle. Over that period, bitcoin (as well as the crypto market as a whole) lost 40% of its value, while the S&P 500 retraced its gains on the year and dropped 14%. The manic highs of the prior year, 2017, were at least partially attributable to the amount of easy money that the Federal Reserve and other central banks globally had pumped into the economy. Risk assets as a whole, from high-beta tech stocks to emerging markets debt, were beneficiaries of all this liquidity – and bitcoin and the rest of the nascent crypto industry had caught that same bid.
I wrote at the time about the wild investments that people were making in the economic context of too much money sloshing around: All the way out on the risk spectrum were tokens associated with “[initial coin offerings] into which investors [had] dumped an estimated $20 billion … often with little in the way of investor rights or protections.” I cannot help but think that number sounds quaint now, both in the context of the valuations that many of those ICO-related projects have ballooned into and also in the context of investors in 2021 and the first month of 2022 having traded more than $30 billion in JPEGs. Some of this volume is of course wash-trading, and of course I am aware these are not actually “just JPEGs.” But still, talk about “risk on.”
The mania of the last couple of years far outstripped what we saw during the 2017 hype cycle. The increase in dollars that have been printed into existence has been absolutely unprecedented since the global coronavirus pandemic took hold: Annual growth of the money supply, which ranged from 3%-7% between 2015 and 2020, spiked to 20-30% in the months following March 2020.
The mania was predictable, the inflation was predictable and now the rate hikes and the drawdowns on risk assets (including bitcoin) are predictable, too. If 2018 is anything to go on, we could be looking at declines in asset values that double (or more) from here. The magnitude and duration of the declines are hard to foresee and will be dependent on whether the Federal Reserve can guide the economy to a soft landing from its current state, flying too close to the sun.
With bitcoin as of yet failing to fulfill its promise of serving as an inflation hedge, it is worth reflecting on what needs to happen in order for it to start trading as such.
Perhaps the most foundational shift that needs to occur in order for bitcoin to behave as a store of value is the market needs to mature. A mature market is characterized by long-term investors who can afford to weather volatility and price drops – and can even take the other side of these trades, lending support and stability to the asset. Often these investors are institutional investors, but I would argue they do not necessarily need to be big traditional banks and asset managers, though those would not hurt. More and more crypto-dedicated funds are in position to be able to serve as these stabilizing forces in the market.
Another hallmark of market maturity is the development of common frameworks, metrics and classifications used across market participants. There are certain heuristics that investors and traders develop over time to rapidly understand, consider, and trade assets. Even the notion of a risk spectrum is an example of this. With risky tech stocks and emerging market assets at one end and with gold and U.S. Treasury bonds as the safe-haven assets at the other end. Investors and traders share an understanding of asset class categorizations and how those categories are broadly expected to trade in various market conditions. There is a recursiveness to the market. Investors expect gold to go higher when inflation ticks up, and so it does!
Today, crypto assets are not yet disambiguated with any sophistication by market participants. In the context of macro markets, bitcoin, ether, ADA, SOL and AVAX are all lumped together. For traders and investors who spend all day on crypto, this is of course not the case, but just watch the next time any mainstream financial news outlet covers crypto. Only rarely are these and other tokens broken out as different categories or classes. For bitcoin to stop trading like a risk asset and start trading as an inflation hedge, it needs to be viewed as a separate asset class from the rest of the crypto markets.
There are signs this is starting to happen, with the likes of Goldman Sachs publishing research separating bitcoin from the others and deeming it a “store of value” to compete with gold. Of course, it will take more than narrative and a few research notes to get there. As the crypto market matures toward mainstream finance, the large investors and traders will need to align not only on classifications but also on the parameters that determine those categories, enabling a more nuanced perspective on bitcoin as well as other crypto assets.
Just as stocks have price-to-earnings and other ratios the markets have coalesced around in order to evaluate them and commodities have their specific supply and demand dynamics, so, too, should the market align on common metrics that matter when it comes to the various categories of crypto assets. Some of these metrics have already emerged and just need to be more widely adopted and viewed as a signal in the context of macro markets.
Some examples of these benchmarks include: inflation rate of the crypto asset; eventual fixed supply (in the case of bitcoin); implied 2030 market cap; and “coin days destroyed” or the number of days a given asset has been dormant in a wallet. These standards exist. They just have not become salient enough and pervasive enough amongst all the major market participants. That there is no clear standard view or categorization for bitcoin is well demonstrated by Goldman itself. Only six months prior to its latest piece on bitcoin as a store of value, it put out a note stating: “We view gold as a defensive inflation hedge and crypto as a risk-on inflation hedge,” failing to call out bitcoin as a possible exception.
The big bitcoin inflation hedge thesis is finally being put to the test in the United States, and it is not faring well so far. As the crypto markets continue to mature and as market participants begin to differentiate bitcoin from the multitude of other crypto assets out there, there is reason to believe that it can still fulfill its promise as a store of value. Market maturity, common valuation frameworks and shared narratives take time to develop, however, so you might not want to put all of your money on bitcoin to hedge the devaluing U.S. dollar just yet.
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