Bitcoin‘s steep decline is undermining proponents’ claims that the digital currency is an inflation hedge.
Since mid-April, the original cryptocurrency has lost roughly half of its value, following a remarkable rally that saw it rise beyond $60,000 from around $7,000 at the start of 2020.It was trading at $31,864 on Wednesday afternoon, with a small boost after Tesla Inc. CEO Elon Musk said he and his space company SpaceX have personal holdings in the cryptocurrency.
The timing is caustic.
For years, bitcoin supporters have touted it as a gold-like inflation hedge, owing to the bitcoin network’s set limit on the number of units that can be created: 21 million. However, their argument had never been put to the test because, since bitcoin’s launch in 2009, inflation has remained largely below the Federal Reserve’s 2% target.
For the first time in many years, shortages of lumber, semiconductors, and labour are putting downward pressure on consumer charges, causing inflation fears. At the same time, governments and central banks have been forced to spend trillions of dollars to prop up their economies, potentially eroding their currencies’ purchasing power.
In June, the consumer price index increased by 5.4 percent, the fastest rate in 13 years. According to the Center for Financial Stability, a nonprofit think tank based in New York, inflation measures in 49 countries have all been rising since the beginning of the year.
Bitcoin, on the other hand, is heading in the opposite direction.The digital currency has dropped in five of the last seven days and is down 7.9% in July, continuing a months-long decline. In 2021, it has increased by 10%.
“Bitcoin‘s price swings appear to be disconnected from macroeconomic fundamentals largely, comprising inflation,” said Eswar Prasad, a Cornell University professor of trade policy who has published extensively on currencies.“It’s difficult to see people purchasing bitcoin as an inflation hedge right now.”
During inflationary periods, other markets are also defying traditional patterns. Gold is down 4.8 percent this year and 12 percent from its all-time high in August. Government bond yields have also fallen in recent weeks, indicating that investors use to be more worried about slowing economic growth than a spike in inflation.
Many investors have largely dismissed inflationary gains, claiming that they are twisted by short-term source disruptions related to the economy’s reopening. Chairman of the Federal Reserve, Jerome Powell, and other policymakers have also stated that such gains are only temporary.
Mr. Prasad believes that scarcity isn’t a reliable source of value in bitcoin’s case. According to him, Bitcoin is more affected by regulatory changes and tweets from influential users than it is by inflation.
“As with any speculative boom, it’s a good asset if gotten at the right time,” Mr. Prasad said.
Many investors agree that speculation remains the primary driver of bitcoin’s price—people purchase cryptocurrency in the hopes of later selling it for a higher dollar price.
Bitcoin, according to Leonard Kostovetsky, an assistant professor of economics at Boston College Carroll School of Management, is “just like buying a lottery ticket.”“For some people, inflation is probably there, but it’s way down the list” of reasons to buy.
The volume of derivatives trading, in which traders do not take physical possession of the underlying asset but instead bet on price, demonstrates the speculative drive. According to a study by Carnegie Mellon University’s CyLab research group, the capacity of trading in the crypto offshoots market use to be anywhere from five to twenty times higher than the volume of spot trading on any given day.
The study concluded that because the volumes are so large, the derivatives market’s movements have driven the overall price action to a large extent.
Kyle Soska, a postdoctoral researcher and lead author on the CyLab report, described the derivatives market as “very, very significant.” He claims that the closing of derivatives contracts alone is able tofix the price, as it did in April when $10 billion in liquidations in a single day accelerated the selloff of bitcoin.
To be sure, both bitcoin’s and inflation’s recent movements are too brief to draw any conclusions, according to Mr. Kostovetsky.“It could be an inflation hedge in the future, but not now,” he said.