Bitcoin's Hedge Potential

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You need not look hard to find people calling bitcoin (BTC) a hedge against inflation, something that should rise in price if inflation is high. For years, that was a common refrain, and it still is in some places. And yet the past year suggests that's not true. Bitcoin has lost more than two-thirds of its value amid the toughest bout of inflation in four decades. Some hedge.

But I think bitcoin was a hedge against something else: inept central bank policy. It’s a seed of an idea that Renzo Anfossi, a senior trader at Arca Funds, planted in my head during a conversation recently – and I believe it explains a lot.

Federal Reserve officials spent months in 2021 saying red-hot inflation would prove transitory. Chairman Jerome Powell didn’t change course until November of that year, when he backed away from calling it a passing phenomenon. Bitcoin skyrocketed up until that point as policymakers appeared to be in denial.

The Federal Reserve poured money into the financial system to prop it up during the pandemic. M2, a measure of the money supply, jumped dramatically from about $15.5 trillion in March 2020 to a peak last year of $22 trillion. The Fed also knocked its main policy rate target down to zero. Dumping all this cash into the system and engaging in unconstrained monetary policy encouraged questionable risk-taking in markets. Bitcoin’s rise was a clear barometer that something irresponsible was going on.

Then bitcoin crashed. It is not, I would argue, a surprise that this largely coincided with the Fed starting to raise rates a year ago – aka getting more responsible. Now, the end of Fed rate hikes to suppress inflation appears to be in sight. The central bank's target rate is now 4.5%, and policymakers have suggested 5% or so will mark the end of their campaign. M2 has fallen some, slipping to almost $21 trillion. The yield curve comparing two-year and 10-year Treasurys remains inverted at about minus 69 basis points, but that's an improvement from minus 84 basis points in early December – a sign of movement toward a more normal economy.

Bitcoin has soared early this year, surpassing $23,000 after being below $17,000 as recently as Jan. 8. Is that a sign of more central bank ineptitude? Not in the U.S., where it seems inflation is getting under control as the easy-money days appear to be far in the past.

What I think is happening is we're entering a period where bitcoin trades on multiple narratives. In the U.S., it’s being viewed as a tool for speculation and something valued for the technology that undergirds it.

Elsewhere in the world, ineptitude could remain a driving force for bitcoin investors. The Chainanalysis 2022 Geography of Cryptocurrency report highlights bitcoin adoption rates around the globe. Not surprisingly, a number of countries that are using bitcoin the most are saddled with numerous issues specific to monetary policy. Venezuela and Argentina, which have key interest rates above 60% and inflation near or above 100%, stand out in particular.

The U.S.-style speculative approach and central bank ineptitude angle seen elsewhere can both be bullish for bitcoin. Things have been considerably bullish in crypto recently, and not just for bitcoin. Bitcoin is up 37% this year and ether (ETH) is up 36%.

How bitcoin ultimately behaves as an asset is yet to be seen. It remains relatively young, and opinions vary by the audience. The goal of “Crypto Long & Short” will be to highlight those views, so that they can be acted upon.

Here’s some news, from CoinDesk's Nick Baker, you should know about: