Last May, Paul Tudor Jones kicked-off the institutionally-driven rally that Bitcoin’s still experiencing today with a letter to investors in his Tudor BVI Global Fund. In that letter, he set Bitcoin up as the next great inflation hedge in a world where global debt is exponentially rising compared to GDP and 6.6% of said GDP had already been created through quantitative easing (money printing).
As 2020 unfolded, other institutions iterated on that thesis until October, when Square, MicroStrategy and others brought back the digital gold narrative to set Bitcoin up as not just an inflation hedge, but a hedge against nearly all difficulties that the traditional financial system can and will bring.
Effectively, the key value proposition for institutions related to Bitcoin is now two-fold. Those who have bought it believe it can function as an excellent inflation hedge and as a safe haven, simultaneously. While we’ve analyzed the safe haven narrative at length thus far, it’s important to dig into what being an inflation hedge entails as well, and whether Bitcoin fits that mold. Here, you’ll find our thoughts on that topic and how it relates to Bitcoin’s potential down the road, especially as the global economy truly begins to recover.
What is an inflation hedge?
On paper, an inflation hedge is an asset or commodity that is expected to grow despite the progressively decreasing value of fiat currencies and can also consequently, grow relatively independently of other markets. Before Bitcoin, the best example of an inflation hedge was gold, since it tended to rise when most traditional markets, including currency markets, fell.
Below you can see gold’s price history over the last decade.
Taking 2020 to the present as our key example here, it’s easy to see that leading up to as well as during COVID-19, gold has provided an effective safe haven against the volatility of other markets, since it grew from $1500 an ounce to $1869.99 an ounce(as of January 21st). If we compare its’ performance to Bitcoin’s over the same period, however, it becomes clear that one fared far better, at least in terms of ROI.
From January 22 2020 to January 21 2021, Bitcoin climbed from $8394.28 to $29571.11. What that means in further context is that in one year, Bitcoin achieved an annualized ROI of 252%, compared to gold’s 24.66%. With this under consideration, it’s clear why 2020 kickstarted a movement towards Bitcoin and to some extent, away from gold, as reported by sources such as JP Morgan Chase & Co.
It all comes down to achieving the best returns possible, during times of economic instability. That is, in effect, the crux of what an inflation hedge should be able to do.
Still, since institutional investors had already begun to hold Bitcoin up as the next great inflation hedge before 2020 ended, it’s reasonable to wonder: what else convinced them of its’ potential?
It Begins and Ends With Bitcoin’s Fundamentals
As Paul Tudor Jones put it in his May 2020 letter, it begins with the invention of digital scarcity.
“It is literally the only large tradable asset in the world that has a known fixed maximum supply.”- Paul Tudor Jones
If you’ve done any digging on Bitcoin up to this point, then you know that this refers to the fact that only 21 million bitcoins will ever exist. This is due to the fact that unlike traditional “fiat” currencies, Bitcoin’s supply isn’t controlled by any bank or government, but instead, by its’ code alone. Therefore, its’ supply is considered to be “immutable,” because it won’t ever be manipulated.
The same goes for how new bitcoins are “issued” or sent out into the world. Since the launch of the Bitcoin network back in 2009, issuance has always been controlled by a measure called the block reward. If you’d like to refresh your memory on what that is, head here. For now, however, it’s enough to picture it as the uncovering of new bitcoins in each 1 megabyte “block” of transactions as it is added to bitcoin’s decentralized database (blockchain).
Both digital scarcity and the block reward are two of the three pillars that make up the leading thesis for Bitcoin’s potential as an inflation hedge.
The third is its’ portability, which refers to the fact that it can be traded by anyone, anywhere, any time. If you know Bitcoin’s fundamentals, then you know that this is made possible by its’ existence outside of the traditional financial system, on a blockchain.
So, how do these three-pillars help Bitcoin’s case as an inflation hedge?
In short, for an asset or commodity to be successful as an inflation hedge, it needs to be liquid, scarce, and experience consistent demand. Bitcoin’s portability fulfills the first requirement, while its’ immutable supply and issuance fulfill the second. It’s the third, i.e., demand, that’s much harder to pin down.
One current theoretical framework that seems to be driving Bitcoin demand is Soros’ theory of reflexivity, which has been summarized by Bitcoin supporters, old and new, as “feedback loops.” Perhaps the best example of this in practices comes from Raoul Pal’s seminal video, “The Bitcoin Life Raft and the New Bretton Woods,” in which he outlined his thesis for crypto’s leading asset from 2020 onward:
“As more people come into the space, the more the price goes up, the more the market cap goes up, the more it attracts people. It is going to create a Soros-style reflective loop of which we have never seen before.”
If you’ve find yourself thinking that you’ve seen this quote before, then you’re not alone. We’ve mentioned it in the past and we’ll be mentioning it again. From the start of Bitcoin’s current, institutionally-driven rally up to now, it’s been in a Soros-style reflexive feedback loop. If you watched its price movements over that time period, then you’ve already seen said loop in action.
Starting with Square, Paypal, and MicroStrategy, the bulk of Bitcoin’s growth has continued to be fueled by institutional investments, especially with regards to its’ usage as a treasury reserve or “safe haven.” This increase in institutional confidence, each time that it’s displayed, tends to push retail investors to dive-in even further.
With this under consideration, we can then circle back to where today’s continued long-term growth began. Yes, institutional investments from October-December of last year pushed Bitcoin to new heights as the chart shows above, but the real question is what drove to them to take the plunge in the first place.
In reality, answering said question is as simple as looking to Bitcoin’s fundamentals, together with what how stock, bond, and other traditional markets developed in reaction to COVID-19. In a nutshell, while other markets experienced considerable difficulties, Bitcoin persisted and even began to thrive the more that 2020 unfolded.
More powerful than its price movements in this respect, however, is the central idea that fueled them. The more institutions and retail investors alike have piled into Bitcoin, the clearer it’s become that the world needs a new inflation hedge. Still, you might logically wonder: doesn’t an inflation hedge have to show consistent growth in tandem with inflation?
2020: Bitcoin and Inflation Rise Together?
To answer the question above, we have to first consider inflation and how it has moved over the past year, then bring said movement up to the light next to Bitcoin’s. Since Bitcoin’s growth, on a global scale, is primarily measured in US Dollars, we’ve taken US Dollar inflation, together with Norwegian Krone inflation, both of which you can see below. The best way to do so is with each country’s respective Consumer Price Index, which, when it changes, is held up as a reliable measure of inflation.
Taking the mean of monthly United States inflation, what we are left with is 1.23% average inflation on the year, which is a small, historically non-significant increase. The latest projection for 2021, however, is that US inflation will rise by 2.2–2.3%, judging by various sources such as the International Monetary Fund and Kiplinger’s.
Norwegian inflation, on the other hand, grew by 1.4% in 2020, which you can see below in data pulled from the country’s Consumer Price Index.
Moving forward, this trend is expected to continue up to 2.4% in 2021.
In both cases, the ideal measure with which to track said growth will remain the respective countries’ Consumer Price Indexes, which can be found here and here, respectively. Keep in mind that when inflation reaches above 3%, investors tend to increase their hedging positions since such levels are historically considered harder to control and the higher inflation goes, the more the value of fiat-currencies drops.
Beyond Inflation Itself: Money Printer Go BRRR
If we look past mere inflation, we come upon a greater, overarching idea that’s fueling Bitcoin adoption, especially today. Fiat currencies can be printed almost ad-infinitum, especially during economic downturns and aren’t backed by anything with a tangible value. As COVID-19 began to unfold and printing money became the go-to option for international governments amidst a progressively uncertain economic climate, Bitcoin returned to the spotlight for one simple reason.
Its’ supply can’t be manipulated by banks, governments, or even individuals.
In other words, it’s “digitally scarce” by default. Each and every theory with regards to Bitcoin’s value has its’ origin in this particular feature, which will likely remain true in perpetuity.
Digital gold is a timeless idea, especially with certain countries’ stimulus efforts already reaching above 10% of their GDP.
So, how did Bitcoin perform in the face of rising inflation?
In the end, the best answer to the above question is: it’s done well thus far but only time will tell. If there’s one key metric to watch, however, as the year goes by, it’s institutional in-flow or AUM. In 2020 alone, Greyscale’s Bitcoin Trust (GBTC) reached over 600,000 Bitcoin under management by the year’s end. If we consider the fact that just over 328,000 bitcoins are mined per year with the block reward at 6.25 bitcoins, then we can say that the GBTC is currently holding the equivalent of close to 2 years of new bitcoins. Additionally, as of December 22, 2020, Paypal alone was funneling more than 100% of new bitcoins into its’ cryptocurrency wallets.
Consequently, the future Bitcoin inflows to these two institutions represent two essential metrics in every Bitcoin investor’s toolkit. Coupled together with the “HODLer” metrics that we discussed in our last post on Bitcoin’s developing supply shock, they effectively give you a powerful toolset for tracking all of Bitcoin’s developing value, including as an inflation hedge.
Nailing down the reasoning behind this is simple.
Bitcoin’s increasing scarcity drives further demand for it. When that demand is regularly led by institutions, then said institutional interest drives further retail demand. Of course, all of this together, raises Bitcoin’s market cap, which in turn, attracts more institutional investors and sends crypto’s leading asset into a feedback loop. So, having the right metrics at your disposal as time goes on means being able to track that feedback loop as accurately as possible.
In the end, these loops increase Bitcoin’s viability as an inflation hedge because they increase its’ growth potential outside of the traditional financial system as long as its’ correlations with traditional assets continue to break down. Digital scarcity, coupled together with proven growth in the midst of economic downturns makes for a truly compelling, timeless value proposition.
Tying it All Together: What Lies Ahead
So, where does all of this leave us?
In the end, everything we’ve mentioned here is just a thesis at this point, especially since Bitcoin’s really only been tested as an inflation hedge in 2020. Over a longer time-horizon such as another decade, it will be truly interesting to see whether the digital scarcity, limited issuance, and decentralized nature of crypto’s leading asset do lead to it truly outpacing gold and reaching the point where it’s a portfolio mainstay across the board and a true inflation hedge. If the tumultuous events of 2020 illuminated one idea above all with regards to these factors, it’s that the consensus seems to be that Bitcoin deserves a place in every portfolio.
As time goes on, whatever twists and turns Bitcoin’s journey takes, you can rest assured that we’ll be there along the way to guide you through it, using the two-fold thesis that it’s developing as both an inflation hedge and an overall safe haven.
With that in mind, in our next post in this series, we’ll move ahead to Bitcoin vs. CBDCs and how understanding that relationship may help to further illuminate the inflation hedge narrative. Until then, remember that we’re here to help you. If you have any thoughts or questions about this post as well as others, reach out to us any time here, on Twitter, or on our website!