As unemployment data from the US disappointed the market, putting investors into a tailspin, all eyes moved to crypto. Seen as a hedge against inflation and recession, would investors switch their equity funds as a form of protection?

 

Well, over the last five days, the price of Bitcoin has fallen from $65,000 to $50,000 and is currently resting around $54,000. This suggests that the perception that crypto provides a hedge against inflation and recession is incorrect, but is it?

 

Why is crypto perceived to be a natural hedge?

 

Even though crypto is relatively new in the world of investment, it has become popular amongst those looking to trade and diversify their portfolios. It does offer something different, a unique structure, and something that is not easily controlled by the authorities. However, there’s a lot more to why many people believe that crypto is still a natural hedge even after the recent Bitcoin price falls.

 

Decentralisation and independence

 

These are two of the main factors associated with crypto's benefits: decentralisation and independence from governments and central banks. Whether the authorities will eventually be successful in introducing regulations to control crypto remains to be seen. Independence alone could make crypto attractive to many investors during economic downturns when central bank policies and government interventions often impact short-term investment returns.

 

Limited supply

 

Many people don't understand the concept of limited supply regarding crypto, especially Bitcoin. In a similar fashion to how gold is seen as a natural hedge against economic challenges, with a maximum of 21 million coins, Bitcoin is often seen in the same light: limited supply. This is especially important when it comes to quantitative easing, the printing of money to refloat economies and combat deflation.

 

Inflation hedge

 

This brings us to the topic of inflation and, as we touched on above, the impact printing money can have on an economy and inflation. Central banks tend to create "new money" to buy back government bonds and some corporate bonds to reintroduce liquidity into the system. This allows banks to lend money to customers and businesses, increasing spending and often strengthening inflation. As the supply of crypto cannot be increased, many see this as a viable hedge against inflation.

 

Diversification

 

Regarding diversification, cryptocurrencies have an unconnected correlation with traditional financial markets. Consequently, this lack of correlation can provide significant diversification benefits to an investment portfolio, potentially reducing overall risk during market downturns. As a relatively new asset class, there is a lot to learn about crypto, but we will see the advent of regulations, although the degree to which the authorities will be able to control trading remains to be seen.

 

 

Growing adoption

 

Whether or not this is an early-stage benefit of cryptocurrencies is debatable, but as they gain wider acceptance and adoption for transactions and are also seen as a store of value, their role becomes more significant. This growing legitimacy can enhance their attractiveness as a hedge during economic uncertainty.

 

So why the sudden drop in Bitcoin after US employment figures?

 

While time will tell, some market observers believe that Bitcoin's recent drop in price doesn't undermine its long-term role as a hedge against inflation. Whether margin calls on crypto markets and investors' flight to liquidity are behind the recent drop in Bitcoin remains to be seen. This may be the first true test of cryptocurrencies as a potential hedge against inflation in recessionary times.

 

Summary

 

It will be interesting to see how crypto markets react in the short to medium term if the US encounters economic turbulence and inflation is reborn in Japan. A significant fall in the price of Bitcoin and other leading cryptocurrencies will be concerning for investors, but this may be part of a wider flight to safety.

 

Crypto sceptics might suggest that Bitcoin's recent volatility reflects an unstructured and unregulated market at its worst. Supporters will point out uncertainty across global markets and a short-term flight to liquidity. Which camp are you in?

Back to News