Hedging bets and growing pains
Views expressed in this article are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.
Unlike most things in crypto, the primary thesis for BTC adoption has remained fairly unchanged since its inception. BTC, as a trustless, decentralised payments network with programmable finite supply, has long been positioned as a viable store of value, and, subsequently, a hedge against fiat inflation.
The past two years have seen this thesis put to the ultimate test, as the US Federal Reserve printed trillions of dollars to stimulate an economy crippled by the effects of the ongoing pandemic. However, in recent months, the Fed has come to a realisation that appears self-evident to most analysts and laypeople – increasing a centuries-old currency’s total supply by ~30% in the space of a single year has consequences (see also: Venezuela, Zimbabwe).
The current state of fiat
Having finally abandoned the perplexing idea of inflation being “transitory”, the world’s most influential Central Bank finally ceded that aggressive quantitative easing would require even more aggressive tapering to curb inflation to ensure that the dollar retains value. This is achieved through two avenues:
Tightening supply – preventing further dilution of USD by curbing the printing of dollars
Interest rate hikes – increasing interest on borrowing, making it harder for individuals and businesses to access further capital
This week, global markets waited with bated breath for the latest Consumer Price Index (CPI) figures – the official metric for inflation. When the Fed ceded its position on the permanence of inflation in November, CPI had already risen to 6,2%, well above the previous high of 5,6% observed during the 2008 Global Financial Crisis. The latest data released on Wednesday revealed that CPI has since risen to a staggering 7%. While high, this figure had already been forecasted and largely priced into macro markets. As a result, major indices such as the S&P 500 and NASDAQ rallied in the wake of the news – propelled by relief that current CPI is not worse than expected.
Trying times indeed (bls.gov)
Bullish for Bitcoin?
Taken in isolation, rising inflation and a devaluing dollar present the perfect storm for BTC to act as intended, as a store of value to hedge inflation. However, as we’ve discovered since the emergence of Covid, we live in a truly globalised, inextricably entangled world, where issues affecting one region can have far-reaching effects felt across the globe.
As a volatile, nascent, and relatively small asset class, crypto remains deeply correlated with macro sentiment across the board. For Bitcoin to be seen as a viable inflation hedge – a safe-haven asset that holds value even as fiat-based economies struggle – BTC needs to be perceived as a stable, low-risk offering. Of course, this is not the case at present, as the currency regularly observes both exponential gains and double-digit drawdowns (precisely the volatility that allows for rampant speculation and life-changing profits).
Given such high volatility in the context of crypto’s wider correlations, BTC has historically overreacted to momentum shifts in Tradfi markets, as illustrated below.
SPX (orange) vs BTC (blue)
Final thoughts
While the numbers regularly seen in crypto appear colossal at first glance, it’s always important to contextualise the industry’s size in relation to the markets it aims to disrupt. Bitcoin, for instance, currently commands a market cap of ~$800B. In comparison, the current predominant store of value, gold, commands a valuation of more than $11T – roughly 11x the size of BTC and >5x the size of the entire cryptocurrency market.
We’ve a long road ahead of us to market maturation, as blockchain use cases continue to grow at unprecedented rates, penetrating industries ranging from tech and finance to identity verification, art, and gaming. In this writer’s mind, BTC’s positioning as a store of value will only continue to gain added impetus as we enter the era of decentralised computing and ownership. However, disrupting an established, globally entrenched financial system is a mammoth undertaking – to say the least. On a time horizon of decades, the trajectory of crypto may indeed be “up only”, but as has been the case historically, the road to further upside and global adoption is paved with the liquidations of overzealous bulls unprepared for the 30-50% corrections that mark every exponential cycle.
Mind the gap (Visual Capitalist)