Since its inception, Bitcoin has gone through countless narratives. One of the more popular beliefs is Bitcoin’s potential to be a hedge against inflation. Most who have heard of Bitcoin have probably also read articles proclaiming it to be a groundbreaking store of value and a new form of digital gold. With its decentralized nature, pseudonymous founder, and a hard-coded fixed supply of 21 million, it is no wonder many who have lost faith in the traditional monetary system can’t shut up about it. In recent years, many financial institutions have jumped on the bandwagon and have begun to recognize Bitcoin’s worth, attributing it to its deflationary design, diversification from traditional asset classes, and speculative properties.
Reading many sensationalized articles about Bitcoin has made us question the validity of these claims. So we put on our big boy pants and did some dirty work to see it for ourselves. Data was pulled and measured across the past 10 years to compare Bitcoin’s performance and its relation to inflation. This led us to discover that not all is what it seems.
Being thorough researchers, we also delved into what others in the market thought about the topic. We gathered a repository of 10 different articles from banks, academic exercises, and research firms and summarized it for our viewers’ pleasure.
Bitcoin, an Inflation Hedge…or an Inflated Story?
In our attempt to answer the question above, we compared Bitcoin’s price and its relation to inflation changes using headline CPI as our key metric. We charted an 18-month rolling inflation beta1 and expected a result with a positive beta to quickly close this chapter. Our findings were rather surprising…
In our methodology, we created a regression of the monthly change in Bitcoin price (%) to the change in CPI (%) from 2010 to Jan 2022 and plotted the rolling 18-month inflation beta as summarized in the chart below.
What We Found
The results showed a sharp disconnect between both variables, especially in the period before 2015 with unusually high beta values (possibly an anomaly given Bitcoin’s low market cap and resulting wild swings) and two other findings across the more recent years:
- 2015- 2020 (Fed Rate Hikes): An inconclusive and directionless relationship between the two variables;
- 2020 – 2021 (Pandemic Era): A rolling inflation beta that strongly suggests Bitcoin as a counter-inflation hedge when inflation has been seen a sharp increase (see below)
These findings were consistent with our other regressions done across varying periods, where we found no statistically significant correlation between Bitcoin’s price and inflation: pre-taper tantrum (2010 – May 2013), post-taper tantrum (Jun 2013 – Feb 2020), and post-COVID (Mar 2020 – Dec 2021).
Short vs. Long Term Inflation Hedging
From the analysis, Bitcoin appears to be an asset with poor hedging characteristics against inflation in a shorter time frame. However, we cannot ignore the fact that Bitcoin has delivered real excessive returns, i.e. nominal return minus realized inflation over the past 10+ years. This is actually similar to equities, which have poor hedging characteristics in the shorter time frame, but provides good real returns in the long term. Therefore, concluding Bitcoin as an inflation hedge could be better put as – generally bad in the short term and generally good in the long term.
Under the Microscope, a More Granular Analysis
Understanding the relationship between Bitcoin and inflation isn’t as simple as crunching one data set. There are many factors that affect how Bitcoin reacts to changes in inflation, the most notable one being market expectations. Our first analysis, therefore, did not give enough color on Bitcoin’s behavior and we felt that it would be more meaningful to analyze how the asset reacted to inflation data deviances from market consensus.
We pulled out the various CPI (commonly seen in headlines), Core CPI (CPI ex. Food & Energy due to their volatile prices), and Core PCE data (main inflation indicator used by the Fed) and attempted to understand if a miss/meet/beat in CPI, Core CPI, Core Personal Consumption Expenditures Price Index (PCE) estimates signaled a change in Bitcoin’s price.
Scoping the Analysis
To conduct the analysis, we (1) sieved out the respective inflation data needed (2) defined the period of analysis, (3) split the period into 2 key parts to analyze due to their different macro environments, (4) sub-segmented into 3 types of inflation consensus deviations, and (5a) analyzed the average % returns and (5b) % days of positive returns for 1, 7 and 21 days post inflation data release. The flow chart below summarizes the key chain of thought, with further details below to explain the diagram:
Defining the Period of Analysis
We chose data from Jan 2018 – Feb 2022 (left-most table), a period where we believe Bitcoin’s market capitalization rose substantially while decreasing in volatility, making it easier to study the relationship between inflation fluctuations and Bitcoin price data. Furthermore, we sub-segmented the period into (1) Jan 2018 – Feb 2020 (middle table – pre-pandemic period) (2) Mar 2020 – Feb 2022 (rightmost table – pandemic period).
Consensus Deviations Categorization
Under each time period, we categorized the analysis into 3 types of consensus deviations:
(1) Above Consensus (Actual inflation data > Consensus inflation Data)
(2) At Consensus (Actual inflation Data = Consensus inflation Data)
(3) Below Consensus (Actual inflation Data < Consensus inflation Data)
Post-Inflation Data Analysis
For the post-inflation data analysis, we conducted it in 3-time frames: (1) 1-day post data release (Price on the next day – Price on the previous day) (2) 7-day post data release (3) 21-day post data release. This was done to see if the price trend continued even 1 and 3 weeks down the road before new inflation data came out on the 4th week again.
Average % Returns (Top Half of Image on Figure 9-11)
Average % returns were taken to see the net effect of all price changes due to a deviation of inflation data from consensus
% Days Positive (Bottom Half of Image on Figure 9-11)
We looked at the proportion of days that the event returned positive results to confirm any relationship rather than just looking at the average returns to identify a relationship between post consensus and Bitcoin.
CPI Data Analysis
The figures from the CPI analysis can be summarized below. Further details can be found in Figure 9.
If above consensus (Actual > Consensus)
CPI inflation data that beat consensus resulted in negative returns 70% of the time over the post 1-day timeframe during 2018-2022. Between 2020 and 2022, hot inflation data gave negative returns 60+% of the time across all 1,7 and 21 day time frames.
At consensus (Actual = Consensus)
There is no clear direction for post 1-day data points, but Bitcoin has shown positive returns 7 and 21 days post-meeting of consensus with a success rate of more than ~70% of the time. On average, these positive returns for 7 and 21 days post-consensus-meet are 1.3% and 2.5% respectively.
Below consensus (Actual < Consensus)
On average, there is a positive return when there’s a miss of estimates of CPI. Bitcoin shows on average a +2% and +1.1% 1 day and 21 days post-consensus-miss respectively. A point to note is that for 1-day post-consensus-miss, Bitcoin returns positively only half the time.
What we found most interesting here is that Bitcoin returns are positive 73% of the time 21-days post CPI consensus miss. Even during the 2018 downtrend, one could have made positive returns based on CPI printing below consensus suggesting that this relationship is trend-agnostic. Of course, given that these are historical results, and the rapid rate at which cryptomarkets are changing, it’s possible that these strategies could become irrelevant.
We believe that if CPI data prints above consensus, it generally results in poor Bitcoin performance. Interestingly, if at consensus, price action 1-day post CPI data release does not yield positive returns on average. On 7 and 21 days post-consensus-meet, we see that there are positive returns 70% of the time. Also, within the timeframe we examined, if inflation comes below consensus, then a trader can find comfort that Bitcoin has returned positively roughly 70% of the time post-inflation data release.
Core CPI Analysis
The figures from the CPI analysis can be summarized below. Further details can be found in Figure 10.
For this analysis, we looked at the “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy”, which is an aggregate of prices paid by urban consumers for a typical basket of goods, excluding food and energy. This measurement, known as “Core CPI,” is widely used by economists because food and energy have very volatile prices.
We summarised the key findings below in a table format for you to quickly sieve through the differences between CPI and Core CPI results.
Core PCE Price Index Analysis
There is no Summary Table for Core PCE Data Analysis as the data is inconclusive. However, further details on the analysis can be found in Figure 11.
In the United States, the Core Personal Consumption Expenditure Price Index (“Core PCE”) provides a measure of the prices paid by people for domestic purchases of goods and services, excluding the prices of food and energy. The core PCE is the Fed’s preferred inflation measure. The central bank has a 2 percent target.
We looked at the Core PCE simply to better understand if the Fed’s preferred indicator tells us anything about Bitcoin’s price movements. Key insights are summarized below.
Core PCE does not seem like a good indicator for Bitcoin price predictions as the price action, in relation to the consensus estimates, seems to follow a random walk. Quite possibly, the Bitcoin market is not factoring Core PCE as much CPI data, which comes out in the headline news more often.
Concluding Insights From All 3 Data Analyses
From our analysis, CPI and Core CPI seem to be good indicators of Bitcoin price movements, while we have not been able to establish a trend between Core PCE and Bitcoin price despite it being the preferred indicator of the U.S Federal Reserve.
Nonetheless, here are some key golden nuggets for the ones who just skipped right here…
Core Personal Consumption Expenditures (Core PCE) Summary
From our analysis, we believe that Core PCE is generally a poor predictor of the Bitcoin markets. This is likely due to traders already factoring in inflation expectations from the CPI data released usually 2 weeks prior and retail traders driving the Bitcoin market based on CPI data since the Bitcoin market is much less mature compared to other TradFi asset classes.
Bitcoin, Everybody’s Doing It!
Our analysis was just one of many attempts at understanding the nature of Bitcoin, and as researchers do, we wanted to see how our conclusions lined up with other research reports. We took a total of 10 reports from banks, academic resources and research firms to get their views on Bitcoin. After burning some midnight oil, we managed to distil the main points brought up by these articles.
- Bitcoin’s highly volatile nature prevents it from having safe-haven potential
- Bitcoin does have a place in portfolios as an inflation hedge, or as a portfolio diversifier which may help portfolios generate alpha
- Bitcoin has delivered excessive absolute returns over the past 10 years in an environment when stocks and gold were suppose to have shone
- Bitcoin continues to fascinate investors as markets continue to understand the uniqueness of Bitcoin and how it may play a role as an asset class
1. Highway To Hell, Not a Safe Haven
In our meta-analysis, 6 out of 10 agreed that Bitcoin’s volatility has made it hard for many to accept the safe haven narrative. Goldman Sachs hit the nail on the head when their paper said that although Bitcoin’s volatility has dropped significantly, it is still too turbulent to provide a peace of mind as a store of value (SoV). Choi and Shin added that Bitcoin’s reactionary movements to financial shocks reject its “safe-haven quality” unlike gold. The authors of “Bitcoin as an Investment and Hedge Alternative” justify that Bitcoin’s volatility is due to its small market cap compared to other asset classes. In conclusion, Bitcoin has a long way to go before it can prove itself as a safe-haven asset. Its relatively small market cap and market sentiment need time to grow as it goes through more stress tests that prove its reliability and continue to grow in adoption.
2. Betty Bought a Bit of Bitcoin to Make Her Alpha Better
The authors of “Inflation and cryptocurrencies revisited: A time-scale analysis” and “Bitcoin: An Inflation Hedge but Not a Safe Haven” agree that there is a correlation between Bitcoin and inflation expectations. In the former paper, their analysis reveals Bitcoin’s responsiveness to positive inflation shocks while the first paper finds that, although limited to recent years, Bitcoin serves as a potential hedge against forward inflation. In another academic paper “Bitcoin as an investment and alternative hedge”, the team approaches the question by finding any correlation between the cryptocurrency, gold, and the stock market. Their findings concluded that there is a near 0 correlation between Bitcoin and the VOO index and gold, reflecting Bitcoin’s ability to hedge against other assets. Ark Invests gave a more fundamental analysis as they argued that Bitcoin serves as a medium of exchange (MoE) that emerging markets have started to adopt due to the instability of their own currencies. Interestingly, the view of Bitcoin as a hedge is a shared view among the papers we reviewed. 7 out of 10 agreed that Bitcoin has shown potential as an inflation hedge and even more so as a hedge against other assets. Whether approached through a historical analysis of price, or by analyzing macro trends both agree that Bitcoin might have a place in the future as a hedging tool.
3. Bitcoin, The Long Game
7 of the 10 papers we reviewed discussed Bitcoin’s long-term performance compared to the stock market and gold in the past 10 years. Interesting points brought up include the higher buying volume for spot Bitcoin compared to gold and the VOO index despite its much lower market capitalization. Additionally, as mentioned by Ark Invest, Bitcoin has provided massive real returns since the cryptocurrency was born, beating both the gold and the stock market during a time of “high inflation, low trust in governments, commodities booming”, a perfect environment for gold. Every report that highlighted Bitcoin’s performance pulled out the 10-year chart of Bitcoin’s price action either against the S&P 500, gold, or inflation. Without a doubt, Bitcoin’s main attraction to many is its impressive gains over the past 10 years, which have dwarfed the movements of traditional asset classes. However, the trend of Bitcoin’s performance in the future will surely change as its market capitalization grows and new narratives sprout, as this long-term outperformance of the stock market may not hold forever.
4. Bitcoin Uniqueness, the 21st Century Snowflake
The general consensus from the papers is that Bitcoin certainly is a different playing field from traditional asset classes. Bitcoin presents hedging characteristics against certain uncertainty due to its decentralized design and the market’s consensus narrative. While at the same time illustrating a strong correlation with traditional risky assets, especially equities. Some of the papers argue that a bet on Bitcoin is betting on a currency that can be a good SoV and an MoE because it is divisible, verifiable, portable, and transferable. Amidst all the assumptions and findings, the most interesting finding would be Bitcoin’s unreactivity to policy uncertainty shocks coherent with its ethos of being borderless and governmentless.
From our rolling inflation beta analysis, Bitcoin is generally a poor short-term inflation hedge based on its sensitivity to CPI. Looking deeper led us to realize a pattern between Bitcoin’s performance and deviation from consensus inflation rates. Both CPI and Core CPI results that beat consensus preceded poor Bitcoin performance while Core PCE consensus deviation had no bearing on Bitcoin’s price.
The papers from banks, academic studies, and research firms discussed how Bitcoin presented some hedging characteristics against inflation and other asset classes. Similar to the studies we found, our data was limited as the analysis was based on historical data and not predictive. Bitcoin and the nascent cryptocurrency sector are still solidifying and so Bitcoin’s behavior to macroeconomic trends will continue to evolve over the years. Even during the time we spent on this article, the narratives surrounding Bitcoin have already changed. Different economies see Bitcoin in a different light whether it is a flight to safety, a protest against an oppressive government, or a chance to make generational wealth.
1 For ‘Inflation beta’, we are discussing the relationship between an asset class’s return and the change in the level of inflation. This ‘beta’ is derived through regression analysis, and the ‘beta’ ultimately represents the slope coefficient of the line between the change in the level of inflation and the asset class return. With regards to inflation, a beta of 5 would suggest that a 1% increase in inflation would lead to a 5% increase in the return of the relevant asset. The data we have used to calculate this ‘inflation beta’ is annual data every month over an 18-months rolling period in order to capture the change in the relationship between an asset and inflation over time.
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