Bitcoin was looking good as an inflation hedge then it plunged nearly 20% – Markets Insider

Bitcoin has risen dramatically in 2021 but is highly volatile.

REUTERS/Dado Ruvic

When the shocking October inflation numbers first flashed through to traders' screens, showing US prices were rising at the fastest rate in 31 years, bitcoin shot higher.

To many crypto fans, the token's gains confirmed what they'd long argued: Bitcoin is the new inflation hedge on the block, and it's "digital gold" for the 21st century that will soon be a key diversifier in portfolios around the world.

But that logic sustained some heavy fire in the last few days when bitcoin's price plunged 18%, from a record high of above $68,600 on November 10 to below $56,000 on Friday.

The inflation-hedge narrative "should come with some very big caveats," said James Malcolm, a top currency strategist at investment bank UBS. "It's not a robust way of thinking about things."

Digital gold

Although bitcoin was originally intended to be a digital version of cash, these days crypto investors are more likely to tell you that it's digital gold.

Like the precious metal, there's a limited supply of bitcoin. Only 21 million coins are supposed to ever be minted, with 18.9 million already in existence. That scarcity should help the cryptocurrency hold its value over the long run, or so the argument goes, even as other assets wobble in the face of inflation or other scary problems.

The view has picked up steam in the past few months. When bitcoin climbed in October, JPMorgan analyst Nikolaos Panigirtzoglou said in a note "the perception" that the token is an inflation hedge was a key factor. Then its price spiked when the inflation numbers came through, delighting the bitcoin-is-digital-gold crowd.

Many drivers

But then bitcoin reminded everyone why most major investors are steering well clear of it - it plunged.

Malcolm, the UBS strategist, said the sharp fall is a reminder there are a lot of other things driving the token. "Inflation is one of many demand-side factors," he said. "It's just a popular one at the moment."

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A key problem for major institutions is that there are a large number of risks surrounding bitcoin, which an asset like gold doesn't face.

Malcolm points to regulation, arguing that it could slow down adoption sharply, which could in turn whack the price. "That should make it a very poor inflation hedge. In the sense that inflation may continue to go up, and crypto can fall a lot more, for all sorts of other reasons," he said.

Bitcoin is 'too raw'

Proponents of the digital-gold argument point out that bitcoin has risen sharply over the last year, when inflation has also climbed dramatically.

Yet skeptics argue that investors can't rely on that trend continuing. If past episodes are anything to go by, bitcoin could fall into another 2018-like "winter" at any time. Back then, its price tumbled from around $20,000 at the end of 2017 to below $4,000 a year later.

Catherine Doyle, a strategist at BNY Mellon Investment Management, said she sees bitcoin as more of "risky" asset like stocks. "It wouldn't be part of that stabilizing base [in a portfolio]," she said. "It just feels too speculative and too raw."

However, it must be said that bitcoin was only created in 2009. Even some of its biggest skeptics admit it could yet become an inflationary hedge, particularly if investors start to really believe it is. JPMorgan's Panigirtzoglou has said there's "little doubt" that bitcoin's competition with gold will continue among investors.

But in the eyes of many big players, it's nowhere near there yet. Rather, it's an asset that's been soaring for a whole host of reasons - and that could easily crash again.

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Bitcoin was looking good as an inflation hedge then it plunged nearly 20% - Markets Insider

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