Historic inflation is pushing the price of pretty much everything higher than it’s been in years. Except for the crypto market, which is moving fast in the other direction.
Bitcoin fell by 30% last week to below $20,000, with ethereum dropping below $1,000. Between the Fed’s regular and ongoing interest rate hikes, conflict abroad, and continued supply chain disruptions, it appears likely that high inflation will last into 2023. It remains to be seen how ongoing inflation will affect the crypto market, but more volatility is a safe bet.
Historically, cryptocurrency experts and investors touted bitcoin, the original crypto, as an inflation hedge because of its limited supply of 21 million and speculative nature. Bitcoin’s value is, in theory, uncorrelated to the stock market, putting it in a category of investments known as “alts” (alternatives) alongside fine art, wine, and precious metals.
But the crypto market has increasingly tracked the stock market in recent months, suggesting it isn’t as untouchable as early adopters say. In May, an algorithmic stablecoin known as Terra (UST) crashed, wiping out $400 billion in crypto market capitalization within a few days.
It’s been a perfect storm, and crypto investors are left to wonder how long-term inflation could impact their holdings. To find out, we asked two financial experts how long-term inflation and crypto are related, and what investors should do to navigate the uncertainty.
How Long-Term Inflation Could Impact Crypto
Crypto is too young of an asset class to know for sure how inflation will affect it, says Brandon Neal, chief operating officer at the DeFi lending protocol Euler and former trader at the Federal Reserve Bank of New York.
“It might not have necessarily been true that crypto was a good inflation hedge. It may have just been coincidental and that, up until now, crypto merely looked like it was a good inflation hedge,” Neal tells NextAdvisor.
Look at gold, for instance: “If you just decided to cherry pick points in time, certain data points throughout its history, sometimes you could look at gold and say it is an excellent inflation hedge — but you’d have to ignore all the times it simply wasn’t.”
More likely, argues Neal, is that bitcoin has created the illusion of a hedge since it was first launched in 2009. But that’s just 13 years of data during a period of historically low interest rates, so it’s impossible to tell whether this will continue to be the case moving forward — especially given how markets and global circumstances have changed.
Chris Brendler, managing director and senior research analyst at D.A. Davidson, says bitcoin could become a good hedge against inflation over time because it’s decentralized and not tied to any central bank, but the current volatility and speculation in the crypto market are overpowering bitcoin’s underlying value since it’s still a new asset class.
The crypto market has been tracking the stock market recently because trading sentiment is taking over the near-term movements and so much of it is “tied to speculation,” Brendler said.
“If there’s a lot of money printing going on, bitcoin should hold its value [over time],” he says. “What we don’t know is how much of it is speculation, and we’re continuing to see that come out. I think it will be proven over time to be an inflation hedge, but not this time.”
What Does Inflation Mean for Crypto Investors?
So if bitcoin — and crypto generally — isn’t the inflation hedge many thought, what role does it have in your portfolio?
“If inflation erodes the value of a dollar over time, people often look for assets that can consistently outgrow the increase of inflation,” wrote Lindsey Bell, chief markets and money strategist for Ally in a February newsletter. “Crypto’s big moves in a year like 2021 had some people feeling digital assets could serve that purpose.”
But as recent weeks and crashes highlight, crypto investing is still highly speculative, especially given that several of the most promising cryptocurrencies today have only been around since 2016 or later. Expect the volatility to continue, experts say, especially amid the broader economic uncertainty we are seeing right now.
Despite what many early believers have predicted, Neal doubts crypto and decentralized finance (DeFi) will replace the role of legal tender — aka the U.S. dollar and other fiat (government) currencies.
“I’m very excited in the long run about the vision of crypto and ancillary innovations like DeFi,” he says. “But I do think it’s important to be realistic in the short- and intermediate-term that the existing system is going to be around in some form or another for quite a while. Legal tender status really, really does matter.”
But in an increasingly globalized world, that’s not to say crypto doesn’t still have interesting use cases that could support long-term value growth.
Russia’s recent invasion of Ukraine, along with the war that followed, offers an example of how crypto continues to offer opportunity even if its value is leaving plenty to be desired among investors.
Anna Vladi, founder at METL, a company that develops tech allowing consumers to buy crypto through the Automatic Clearinghouse (ACH) network, encouraged her remote, Ukraine-based employee to accept a portion of her salary in stablecoins prior to the February 2022 invasion by Russia. This would in theory offer a way to shelter some liquid assets from an invading hostile power and the uncertainty that comes with war.
“I always paid her by wire in U.S. dollars,” says Vladi. “But eventually, when the rumors were circling around, I [asked] her … ‘Do you think maybe you want to at least partially take something in crypto because if anything does happen … there’s going to be sanctions … funds are going to be frozen? You want to have alternatives, and this way, you can get out.’”
Vladi’s employee evacuated to Greece, where she was able to transfer her stablecoins back to dollars and cash out. This was fortunate, says Vladi, while her home country lived in fear of a bank run.
The decentralized nature of crypto makes it possible for refugees to exchange money, buy goods, and barter, Vladi says.
“Everybody downloaded MetaMask [digital wallets] and people started paying each other for different things — diapers, baby food, whatever it was … I truly believe in emergency situations just like this, this is when [crypto’s value] comes to light.”
How to Inflation-Proof Your Portfolio
So if bitcoin isn’t exactly the inflation hedge it’s been made out to be, what does it mean for investors? Is it still worth holding in your portfolio, or sticking to an investment strategy that includes a share of crypto?
Diversification is the best inflation hedge — not a single asset class in itself.
Experts say diversification is still the best inflation hedge. Diversification simply means adding a robust array of different asset classes — stocks, bonds, ETFs, and index funds — to your portfolio.
For crypto-curious investors, financial planners and other experts recommend keeping crypto investments to less than 5% of your overall portfolio. They also say it’s smart to invest in crypto only what you’d be OK losing if its value dropped to zero. And you shouldn’t invest in crypto before building an emergency fund and paying off any high-interest debt.
The majority of investments, experts say, should live in broad-market funds that comprise several sectors. ETFs can help diversify your portfolio better than cherry-picking individual stocks, and this spreads out the risk (if one company tanks, there are still many more doing OK in your portfolio). There are even blockchain ETFs, which let consumers invest in companies known to have either invested in blockchain or that incorporate the crypto technology into their business.