Bitcoin is a conversation with fiat.
It isn't independent. It's contextual. It's relational. Bitcoin is contextualized by the existence of fiat, and hopefully, fiat becomes contextualized by Bitcoin.
It's like hot and cold, light and dark. Bitcoin is the absence of monetary intervention, while fiat is money optimized for and defined by monetary intervention.
Steven Lubka, a CoinDesk columnist, leads Swan Private, Swan Bitcoin's concierge service for high-net worth investors. This article is part of CoinDesk's "Trading Week."
Bitcoin, without fiat, is just money. Fiat, without bitcoin, is just money.
Starting with this lens we can discuss why bitcoin has been correlated to the unique macroeconomic environment we are in which has been decidedly negative for practically all assets.
You can hear it when people talk about bitcoin:
"Wasn't bitcoin supposed to be independent of traditional markets?"
"Wasn't bitcoin supposed to be an inflation hedge?"
For an asset which is supposed to provide an alternative to contemporary finance, why has bitcoin been so correlated to traditional markets and central bank policies?
If bitcoin is anything, it's an alternative to fiat. Call it a hedge, call it an escape hatch, call it whatever you want. It's something you can own in case the current iteration of the dominant money system fails or becomes dysfunctional (or already has).
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Thinking deeply about this, one should realize this implies a relationship between bitcoin and the current system. When the current system is engaged in reckless expansionary policies, in the debasement of the numeraire, bitcoin should become more valuable relative to whatever abused fiat currency you are measuring it against (and measuring it with).
So what happens when the inverse occurs? What happens when the hegemon contracts the money supply – when they tighten the monetary policy? What happens when liquidity disappears? What happens when growth inverts?
If bitcoin appreciates in value relative to fiats when monetary expansion takes place, it follows that it could decline in value when the fiat system tightens and contracts.
That's precisely what has happened. When the COVID-19 stimulus plans and massive quantitative easing were announced you could have bought bitcoin between $6,000 and $9,500 for over a month (even if you didn't catch the bottom).
Over the next year bitcoin outperformed every major asset class, and even today, after the precipitous drop from all-time highs, bitcoin has still outperformed the S&P 500 and Nasdaq 100 by a huge margin if you bought both at the beginning of the pandemic, before the expansionary monetary policies began.
Since June 2020, bitcoin went from $9,500 to today's price of $19,500 over a 100% return. In comparison, the S&P 500 went from 3,000 to 3,700, slightly over 23%. Bitcoin bought prior to the monetary expansion has outperformed other major asset classes, even today after a more than 70% decline from the highs.
Bitcoin's price rally was consistent with the direction of monetary expansion, and its collapse (along with every other asset) was consistent with the reversal of this direction of monetary expansion – a huge contraction.
The contraction wasn't limited to central banks stopping QE. It also included artificially raising interest rates, along with a collapse in other financial assets which also serve as part of the money supply (in practice if not in theory, at least).
Financial assets, equities and real estate represent most of the dollar-based liquidity that Americans own. Actually, dollars are a far smaller slice of the pie.
When the total value of U.S. financial assets declines by over $20 trillion, there is significantly less total dollar-denominated financial value sloshing around the world. What is this if not a contraction of the money supply? Paul Krugman might disagree with me on a semantics basis, but I don’t care about semantics, I care about how reality functions.
Low-interest rates, rampant money creation, and rising financial asset values (and premiums) led to bitcoin outperforming all other asset classes. Rapidly increasing interest rates, a cessation of money creation and crashing financial asset values (and premiums) led to a steep drop in bitcoin’s dollar denominated price.
Can I back up this point of view? Yes, let's look at gold. Gold is down 19% from its all-time high. This is meaningfully less than bitcoin, but it is still an example of the market's most commonly accepted “inflation hedge” declining in a macro environment with inflation at multi-decade highs and geopolitical tensions.
See also: Dollar-Cost Averaging Explained | Trading Week
The common thread is any discussion of “inflation hedges” is only relevant insofar as we use the actual and original definition of inflation – monetary expansion. The modern semantic switch to inflation representing consumer goods prices doesn’t help us here.
Gold and bitcoin are both inflation hedges in this sense. They appreciate when the fiat money supply is expanded and they decline when that money supply contracts.
Consumer good price increases due to decades of malinvestment, under-investment in commodities, supply chain disruptions, and deglobalization do not constitute a boon for fixed monetary, assets that should appreciate in value as economic growth increases.
Bitcoin’s price performance in 2022 is not evidence of a failure for bitcoin or even a failure of narratives around Bitcoin when properly contextualized. It is solely evidence of rapid destruction of liquidity and profound geopolitical disruptions.
The good news for bitcoin investors is that a prolonged contraction of economic growth and of credit will eventually render the system totally insolvent. While this would be devastating, our esteemed central planners will eventually stop short of this and engage in a jubilee of monetary and fiscal support.
While anything is possible, the skillful deleveraging and austerities that would be involved in avoiding the inevitable monetary debasement appear far beyond the means or appetite of the current political apparatus. Therefore, the base case is more monetary expansion, and more debasement of fiat.
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And when this comes, bitcoin will likely continue to be the best-performing asset relative to all other major asset classes.