- An increasing number of investors, both institutional and retail, are looking at Bitcoin as a hedge against rising prices — inflation.
- Inflation is considered to be a ‘necessary evil’ in any growing economy, including India.
- Critics argue that Bitcoin may have delivered higher returns than other assets like gold or equity stocks, but it is also more volatile.
One of the biggest arguments in favour of Bitcoin is as ‘ digital gold’ — a hedge against rising prices, or inflation.
As an example of price increase, India’s Central Statistics Office reports that the price of milk has increased by 47.3% in the eight years since 2012, even though milk production increased by 47% over the same period. Supply has increased, but so has the cost.
One can see rising prices of goods just about everywhere else as well. Economists say a large part of this is simply because the ‘purchasing power’ of money — such as the Indian rupee — decreases over time, and is tolerated as a necessary evil to fuel the overall economy.
However, prices denominated in Bitcoin are claimed to be able to beat back this trend thus helping the currency retain value. “Institutional investors appear to be returning to Bitcoin, perhaps seeing it as a better inflation hedge than gold,” said US investment banking behemoth JP Morgan Chase in a note to investors.
Everyone’s in a race to beat inflation
Back in 1973, one US dollar could be exchanged for eight Indian rupees but the exchange rate in 2021 stands at almost ten times that, as seen in the graph below. During the pandemic, one of the primary concerns was that even the interest on fixed deposits (FDs) was unable to beat the rate of inflation.
If the dollar was rising against the rupee, in turn, the value of gold has been rising compared to the dollar.
© Stooq/BI India
This cycle of inflation explains why a loaf of bread costs a lot more today, than it used to. The falling value of fiat money drives most investment decisions. You want high returns on investment to keep up with price inflation, you expect earnings to keep rising until you retire, and so on.
When a national currency is used, inflation is inevitable in a growing economy. It helps because the more money there is in the economy, the higher is the demand for goods and services. That benefits workers with rising incomes, but certain profiles of people such as students and retirees — those with a fixed income — are negatively affected.
The mythical zero-inflation currency
In theory, one way to prevent continuously rising prices is to use a currency that ‘retains’ value – like the gold standard. That will lead to the benefit of ten rupees buying the same quantity of goods, whether today or ten years later.
Such a system was found to be imperfect though, suppressing economic growth and trade in goods, among other ill-effects. That is why the task of retaining value is now left to assets and investments instead.
Can Bitcoin be a ‘reserve’ currency?
There is a limited supply of Bitcoin – partially like gold. Moreover, the last few years have seen the price of Bitcoins rise faster than other financial instruments, fast enough to retain the value of money and then some. That has enthusiasts on social media asking whether Bitcoin is a preferred investment.
When tracked across a decade, Bitcoin has indeed made profits for those who held it for a long time. Changes enforced by its inbuilt protocols such as ‘the halving’, are also expected to push its value higher. So denominating a portion of wealth in this cryptocurrency, could mean gains that offset probable losses in other areas of a person’s investment portfolio.
In fact, large institutional investors and cash rich companies have been slowly buying and showing it on balance sheets as part of assets held. In the case of MicroStrategy, even a drop in their primary revenue earned turned out to be trifling, when the increased value of Bitcoin assets padded their balance sheet by a billion dollars.
Is Bitcoin-ing the world desirable?
Like any early adopter, being ahead of the curve in buying into this cryptocurrency could help – until enough people hold Bitcoin as an asset, that it can be used as a currency to transact for goods and services. After that point, people could use it widely for transactions like a normal currency, thus possibly stabilising its value.
For the moment however, the dollar-value of Bitcoin continues to fluctuate wildly, to the tune of three percent between the morning and evening of the same day. That could be an opportunity or a risk, depending on whether you are selling or buying the currency.
Existing real-world conditions could hold lessons for crypto enthusiasts. Japan has had almost zero inflation for two decades now – a dream of cryptocurrency enthusiasts – yet that hasn’t significantly helped the Japanese. El Salvador has officially welcomed Bitcoin for day to day transactions, yet there have been a number of protests against this step.
Some enthusiasts even consider Bitcoin to have deflationary tendencies, wherein goods may cost lesser when denominated in Bitcoin terms. That is because such a cycle could keep reducing prices, wages and production with disastrous consequences for people. Hence most economists today advise avoiding such a path of intentional deflation, although it could still play out in unforeseen, innovative ways with Bitcoin.
Best case for an anti-inflation Bitcoin hedger
Those who believed in Bitcoin and stayed put — the HODLers — managed to gain extraordinary returns, like Michael Saylor owned IT company MicroStrategy.
The rise of Bitcoin over the past few years suggests that it could be treated as another type of asset for an individual or institution, serving the role of diversifying investments. It could then try to balance out adverse movements in other asset classes.