Is Crypto Still a Hedge Against Inflation?

Many cryptocurrencies have made enormous returns in the past years, but we know that past performance is no guarantee of future results. It highly depends on the time frame you choose to analyze, since one asset can outperform another asset during the cyclical uptrends and downtrends of different asset classes. In this article, I will be briefly touch upon the idea of inflation, checking for returns since the beginning of 2021 for Bitcoin, Gold, and SP500 first, and then for other cryptos.

What is Inflation?

Usually measured in percentages, inflation shows how purchasing power in a given currency has changed during a time interval. A popular metric used for the calculation of inflation is CPI. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. While checking the website of the Bureau of Labor Statistics, it can be seen that Energy – one of the major categories, has seen a 30% increase in the 12-month time frame. In Germany, the average expected inflation for April 2022 was 7.4% according to the Statistisches Bundesamt. But the target usually was 2% on average. One of the major drawbacks of the CPI is that choosing a basket of goods and services is subjective and can be varying across the regions. 

Michael Saylor, CEO of Microstrategy, has put out that “…the methodology for calculating inflation is to collect a market basket of consumer goods – that is cherrypicked – and calculate CPI. But in fact, a more sophisticated understanding is inflation is a vector! Inflation is taking place at a different rate across different goods and services…”

Long story short, the inflation rate for the whole economy usually will be different than the one you experience now. Especially, if you live in a big metropole, it is highly likely that you are experiencing a higher inflation rate than other regions of your country. 

How has Bitcoin vs Gold vs SP500 Performed in the Past Years?

Amid the decaying purchasing power, declining asset prices have been another hit recently for investors. You can think of inflation as a small hole in a boat, and water always comes in. If the hole gets big enough, most likely your boat will sink eventually. That’s why keeping only cash in the long run will lead to significant decreases in one’s purchasing power. The way to hedge against inflation has been investing in stocks, gold, property, and recently crypto.  But how was it specifically in the last 1, 2, and 3 years? In order to see that, I looked at the cumulative returns of the Bitcoin, Gold, and SP500 index from Jan 2020, 2021, and 2022 to today. Bitcoin’s massive rally in 2020 still allows it to be at the top by a huge margin, even though returns in 2022 significantly decreased. Bitcoin yielded a 319% return from the beginning of 2020 until May 13th, 2022. During the same period, SP500 had a return rate of 23.5%, while Gold gained 18.3% in the same period. Despite the recent plummeting price of Bitcoin, it has been able to beat SP500 and Gold by a large margin.

On the other hand, while looking at the returns from the beginning of 2021 until May 13th, 2022, the SP500 is the winner and the only positive one in terms of the cumulative return rate. Despite Bitcoin hitting its all-time high in November 2022, the price plummeted significantly. If you invested 1000 € in SP500, Gold, and Bitcoin at the beginning of 2021, by the end of May 13th, 2022 you would have 1008.7 €,  992.9 €, and 991.6 € respectively. If you add inflation to the equation, the real return of all these assets is negative. 

Finally, after performing the same analysis from the beginning of 2022 until May 13th, 2022, SP500 and Bitcoin are yielding negative nominal returns, while gold has a mere 0.44% positive nominal cumulative return rate. The outbreak of war in February made the gold price jump over 10%, but the others suffered significantly. However, the year has not ended yet, and it is early to make a judgment. 

How do Other Cryptos Compare to Each Other?

While in 2022, Altcoins (an altcoin is an alternative digital currency to Bitcoin) suffered even more compared to Bitcoin, but in the bull market they yielded higher cumulative returns, too. The highest nominal cumulative return rate yielded by Axie Infinity (AXS), a non-fungible token-based Play-to-earn online video game, at 3623%. It means that 100€ invested at the beginning of 2021 at AXS, would still give you 3623€ euro today despite the recent market turmoil. More importantly, all altcoins still have a positive cumulative return rate as shown below. 

Conclusion 

In this article, the definition of inflation is revisited again. It was argued that CPI as a way of calculating the rate of inflation might not capture the actual inflation that one experiences. Followingly, the cumulative return of Bitcoin, SP500, Gold, and then Altcoins has been depicted in different time horizons. It was noted that in the longer term, Bitcoin has significantly higher returns compared to SP500 and Gold, while in the short term, SP500 and Gold performed better. It should be iterated once again that past performance is no guarantee of future results. Investors, however, by diversifying and allocating a small portion of their portfolio to crypto, might benefit from tailwind returns.