Bitcoin Fails First Inflation Test As Sell Intensifies

The timing is ironic.

Bitcoin supporters have touted it for years as a hedge against inflation like gold, mainly because the Bitcoin network has a set limit on how many units can be created: 21 million. However, their argument had not been tested before, as inflation has been well below the Federal Reserve’s 2% target since Bitcoin launched in 2009.

For the first time in years, shortages in semiconductors, wood and labor are putting pressure on consumer prices, raising concerns about inflation. At the same time, governments and central banks have been forced to spend trillions to support their economies, potentially undermining the purchasing power of their currencies.

The consumer price index hit 5.4% in June, its fastest pace in 13 years. And inflation measures in 49 countries have all increased since the start of the year, according to the Center for Financial Stability, a New York-based nonprofit think tank.

Bitcoin goes the other way. The digital currency has fallen in five of the past seven days and is down 7.9% in July, extending its sale for several months. It is now up 10% in 2021.

“Bitcoin’s price movements appear to be largely disconnected from macroeconomic fundamentals, including inflation,” said Eswar Prasad, a professor of trade policy at Cornell University who has written extensively on currencies. “At the moment, it’s hard to see people buying bitcoin as a hedge against inflation.”

Other markets also oppose traditional patterns during times of inflation. Gold is down 4.8% this year and 12% from the August record. Government bond yields have also fallen in recent weeks, suggesting that investors are more concerned with the slowing outlook for economic growth than with soaring inflation.

Many investors largely ignored the inflation gains, seeing them as distorted by short-term supply disruptions linked to the reopening of the economy. Federal Reserve Chairman Jerome Powell and other policymakers have also said they expect these gains to be transitory.

In the case of bitcoin, scarcity by itself is not a stable source of value, Mr. Prasad said. Bitcoin, in fact, is more sensitive to regulatory changes and tweets from influential users than to inflation, he said.

“It is a good asset if it is obtained at the right time as with any speculative boom,” Mr Prasad said.

Many investors agree that speculation still seems to be the primary driver of the price of bitcoin – people buy cryptocurrency because they think they can sell it later for dollars.

“It’s like buying a lottery ticket,” said Leonard Kostovetsky, assistant professor of economics at the Boston College Carroll School of Management, of Bitcoin. “Inflation is probably there for some people, but it’s low on the” list of reasons to buy.

The speculative surge can be seen in the volume of derivative transactions, in which traders do not physically take possession of the underlying asset but simply bet on the price. The volume of transactions in the crypto derivatives market is five to 20 times greater than the volume of spot transactions on any given day, according to a study by the CyLab research group at Carnegie Mellon University.

The volumes are so large that movements in the derivatives market have to a large extent driven the overall price action, the study concluded.

“This is very, very important,” said Kyle Soska, postdoctoral researcher and senior editor of the CyLab report, of the derivatives market. The liquidation of derivative contracts alone can determine the price, he said, as happened in April when $ 10 billion in single-day liquidations sped up bitcoin sales.

To be sure, recent moves in bitcoin and inflation are too brief to draw any conclusions, Kostovetsky said.

“It might be an inflation hedge someday, but not now,” he said.

Write to Paul Vignes at [email protected]