Cryptocurrency as a protection against inflation: myth or reality

Why saving from inflation is just a myth, says Aaron Chomsky, head of investment department at ICB Fund

The narrative that Bitcoin is digital gold in 2022 is not confirmed. Against the backdrop of accelerating inflation (for example, a record for 41 years has been updated in the United States), investors did not use the first cryptocurrency as a tool for saving capital. On the contrary, the correlation with the stock market has increased, especially with the sector of high-tech companies. In other words, Bitcoin behaved like Tesla shares.

It is fair to say that gold did not save its owners from dollar inflation either (growth in geopolitics in February-March completely came to naught), since the financial authorities of the world are extremely unprofitable for the rise in the price of the precious metal - this is a loss of confidence in fiat currencies.

The world is currently experiencing a unique period - the retribution for the unrestrained work of the printing press of the leading central banks. The actions of the monetary authorities led to inflation of assets - inflating the bubble across its entire spectrum. Now there is a reverse process, as a result of which diversification does not work - even bonds, which previously smoothed out portfolio volatility, become cheaper.

Some, like Bill Gates, are buying up agricultural land, some are looking for stocks in emerging industries and waiting for favorable valuations, some are sitting in cash and waiting for the formation and completion of a new bear market wave. One thing is clear - there are no ready-made solutions now (except perhaps the purchase of inflation-linked bonds). Now is the time for traders. Investors need to wait for a reversal in the Fed's policy, which will come no earlier than the spring of 2023, and even then with reservations.

Bitcoin, inflation and the Fed

Why is cryptocurrency not the most reliable means to fight inflation? What are the key reasons? How does high inflation affect the cryptocurrency market and investor behavior in general?

Bitcoin hit all-time highs in November 2021, four months before the first Fed rate hike in March 2022. The fuel for this movement was the quantitative easing program, which increased the money supply in the system. It is with it, and not with inflation, that Bitcoin correlates.

Read also: Bitcoin exchange rate may return to $18,000 in August

According to Spydell, since the start of the Fed’s monetary policy tightening cycle, from February 2022 to June, the M2 money supply in the US in real terms decreased by 4% (a record contraction since the 1930s). Bitcoin during this time actually doubled.

From March to the end of July, over the course of four meetings, the Fed raised the key rate range from near zero to 2.25-2.5% per annum. At the same time, representatives of the open market committee said that in order to fight inflation, they are ready to bring this level up to 4.5% per annum next year and hold it for a while to reduce inflation expectations (as the Bank of Russia did). Current market expectations are limited to raising the rate to 3.5% per annum and starting policy easing as early as March 2023.

Read the BeInCrypto article to find out why the bitcoin rate rose after the Fed raised the key rate.

Tightening policy (and this is also reducing the Fed's balance sheet due to sales of government and mortgage bonds purchased during the pandemic) is holding back economic growth. The debt market is signaling the possibility of a remake of the 2008-2009 crisis. The growth of rates in itself suppresses the demand for risk (this is laid down by the mechanics itself through the discount rate).

As the events of recent months show, bitcoin and stocks are in the same boat. This is due, among other things, to an increase in the share of institutional investors. Therefore, there are no prerequisites for a return to historical highs at least until the spring of 2023. Bitcoin is not a hedge against inflation, but a risky asset, at least at the current historical stage.

Article written by Aaron Chomsky, Head of Investment at ICB Fund