Crypto Perspective 3: Inflation Hedge?
Moving on with our discussion of the problems of categorizing Crypto, we come to what has emerged as an important question – do Cryptocurrencies serve as a hedge against inflation?
This question has become ever more pertinent over the decade or so of Bitcoin’s existence, as the world’s major central banks, the Fed, ECB, and BoJ have implemented round after round of QE. Since QE is widely thought to be money printing, even though it is not, mainstream narratives have become focused on the idea of fiat debasement, and the inflationary threat that poses.
A natural extension of that discussion is what assets to own as a hedge against such inflation – other than silver and gold, what could be better than decentralized Cryptocurrencies not issued or controlled by governments? Which of course begs the question, do Cryptocurrencies really hedge against inflation?
3. Is it an asset that hedges against inflation?
In order to investigate this question, we calculated the correlation between BTC and Personal Consumption Expenditures (PCE), as well as the correlation between Gold and PCE.
However, it is important to understand that Bitcoin has only been around for about a decade, and BTC is the oldest Cryptocurrency on the block. Out of those ten years, it has only been part of mainstream financial discussions for somewhere around 5.
Which means that there simply isn’t enough data with which to calculate longer term correlations between BTC and inflation.
As such, our little thought exercise is focused on 1 year rolling correlations over a period of slightly less than 10 years for both BTC vs PCE, and Gold vs PCE.
Correlations were calculated using the YoY returns of BTC and Gold (using monthly price data), and the YoY change in PCE; not real PCE, since real PCE is constructed to account for inflation.
As a side note, the choice of index between PCE and real PCE does not make much of a difference in how the trend in rolling correlations change for both BTC and Gold.
For those unfamiliar with how correlations work: in order for an asset to be considered a hedge against inflation, its price needs to increase as inflation increases.
This means a correlation coefficient above 0, with a maximum value of 1. Higher values represent a higher positive correlation.
Should an asset be negatively correlated with inflation, its correlation coefficient will be below 0, with a minimum value of -1. Lower values represent a more negative correlation. This means that the asset’s price moves opposite to inflation, and as such is not a good hedge against it.
As can be observed from the chart above, BTC has become increasingly positively correlated with PCE over the last 18 months or so.
The 1 year rolling correlation climbed from just above 0 in 2020, to reach a high of 0.7 in the first quarter of 2021.
This indicates that BTC has indeed proved to be a useful hedge against inflation, at least for the past 1 and a half years. (and on the basis of 1 year rolling correlations)
However, from a longer term perspective, correlations between BTC and inflation have constantly shifted between 1 and -1. That is, over the past 8 years, Bitcoin has spent some periods moving in tandem with inflation, and other periods moving opposite to inflation.
To be continued…
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