For years, crypto enthusiasts have touted bitcoin as an attractive inflation hedge. That was an easy claim to make during years of little to no inflation, and then in 2020, the theory seemed to hold up. However, when inflation reached 40-year highs in 2022, bitcoin’s naysayers quickly pointed out that the cryptocurrency did not serve as an inflation hedge at all.
As many market watchers debated why bitcoin failed to act as an inflation hedge in 2022, it seems clear now that bitcoin hedges against only one source of inflation — and not the other.
Why bitcoin is a long-term inflation hedge
Bitcoin is a long-term hedge against inflation because of its limited supply. Over time, the production rate on bitcoins declines as the rate of dollar production increases. As a result, the price of bitcoin in dollars should rise in the long term. In fact, the bitcoin price has increased much faster than the dollar has lost value.
“In the short term, inflation usually rises for one of two reasons,” explained Seasonal Tokens founder Ruadhan O. “Either central banks are printing excess money, injecting more money into the system without the production of new goods and services, or there are shortages of goods caused by supply chain issues.”
Just as the economy and financial markets go through cycles, so does the Seasonal Tokens ecosystem. However, while the economy and markets experience boom and bust cycles that can sometimes be unpredictable, Seasonal Tokens create a system in which the rises and falls of each of the four tokens are predictable.
When people talk about the government “printing money,” they aren’t talking about literally printing dollar bills. The term is widely used to refer to the money that’s artificially created by the Federal Reserve when they expand their balance sheet through purchases of corporate and government bonds. The Fed generally “prints” money this way to deal with the bust parts of the economic cycle.
Why bitcoin hedged against inflation in 2020
When central banks print too much money, prices rise because the value of the dollar declines. Essentially, it’s a matter of supply and demand within the monetary system, so the value of the dollar declines because the supply of dollars is too high.
This type of inflation is precisely what bitcoin is designed to hedge against. In fact, the idea for bitcoin came out of the Great Financial Crisis, when the Federal Reserve bailed out the nation’s largest banks. The process involved printing a lot of extra money to provide them with the support they needed to avoid collapse.
As a result, it’s no surprise that bitcoin did act as an inflation hedge in 2020, when the federal government printed trillions of dollars during the COVID-19 pandemic to support American families during the nationwide lockdowns.
Unfortunately, the circumstances created the perfect storm, guaranteeing that the amount of money in circulation would exceed the value of the goods and services produced. Data from the Atlantic Council suggests the world’s major central banks have printed more than $11 trillion, in aggregate, since 2020.
It’s no wonder the price of bitcoin soared in 2021, thanks to the inflationary effect of the newly printed money combined with the reduced supply of bitcoin following the halving in 2020.
Here’s what was different in 2022
“When inflation reached 40-year highs in 2022, it was a different story,” Ruadhan said. “The Fed had ended its program of quantitative easing, and the economy was flush with cash. However, the supply chain issues that started during the pandemic continued, and the resulting inflation was exacerbated by all that extra cash.”
Demand soared as the world moved out of the pandemic, but the global supply chains couldn’t keep up. Geopolitical conflict increased those supply shortages even more. After Russia invaded Ukraine in February 2022, the U.S. and Europe imposed sanctions, and Russia cut Europe off from its much-needed energy supply.
As a result, energy costs skyrocketed in the U.S. and Europe. As energy, production and transportation costs rose, the prices of almost all goods surged, resulting in the highest inflation rates since the 1980s. Food prices also rose dramatically due to the rapidly increasing price of fertilizer.
Other key factors that drove food prices higher included trade restrictions on grain and outbreaks of avian flu, which required the culling of millions of chickens and poultry.
Opposing inflationary forces
As the last two years have demonstrated, the price of bitcoin doesn’t rise in response to inflation caused by supply shortages. The higher prices reduced consumers’ disposable income, leaving less money to invest in bitcoin.
In fact, the cryptocurrency’s price declined throughout 2022 as inflation soared due to widespread shortages of tangible commodities — rather than excess money printing.
