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Maybe you’ve heard a story about someone who sold their home, then took some time off to consider their next moves, only to find a few months later that their assets had depreciated by 10-20% and the housing market wouldn’t let them back in at a comparable level. I recently heard this exact story. It’s a good lesson about finding the right inflation hedge and moving fast to keep your capital safe.
Recent statements from the Federal Reserve indicate that current high inflation rates are more than just transitory. This means that it’s a good time to start looking for an effective inflation hedging strategy, or else you might end up like the homeowner in the anecdote above.
It’s not the first time we’ve experienced inflation like this, but this time around investors are looking at new assets like Bitcoin and other digital assets as inflation hedges.
Crypto strategies for inflation hedging can help maintain purchasing power in the midst of high inflation and economic uncertainty. In this post, we’ll explore how and why.
Inflation News
Last week’s inflation news revealed that the Consumer Price Index has climbed by 8.5% since April 2021. According to the US Bureau of Labour Statistics, it took $111 in March of 2022 to buy a bag of goods that would have cost $100 in March of 2020; an 11.3% increase.
Source: (US Bureau of Labor Stats)
Inflation rates are now at a 40-year high and savvy investors are searching for assets that can hold relative value.
When inflation rose above 7% in the 1970s the Fed raised interest rates to meet inflation losses, similar to what we see many central banks doing now. At that time, higher interest rates eventually lowered inflation back to its target of 2%. But the change was painful.
A world where interest rates are 7-10% (as they were in the 70s) is a different world, affecting how people invest and how people save. If interest rates remain high, the higher cost of borrowing has been known to slow the economy.
Inflation Hedges: How to Hedge Against Inflation?
At this time, you may be asking, what’s a good inflation hedge? Traditional answers include assets like precious metals, commodities, and real estate.
These tried and true pillars of stability consistently retain value, allowing consumers to maintain buying power. In 2022, this traditional wisdom holds true, but there are a few new twists.
For one thing, inflation isn’t at normal levels; it’s at high levels. Investors need to make sure gains in their portfolios are beating high inflation rates.
A second factor is relatively high levels of uncertainty. COVID-19 recovery is still underway and while first indications look positive, the jury’s still out on long term effects. Further, the war in Ukraine and western sanctions are driving up energy prices (one reason for the high inflation): and China’s zero-COVID stance might indicate further severe economic lockdowns.
Gold and other precious metals have maintained consistent growth in the face of growing inflation, more than matching the two year 11.3% rise in prices. It seems precious metals will continue to hold value while cash holdings depreciate, as they have in the past. The chart below, of gold ETF – Aberdeen Physical Gold Shares (SGOL), shows consistent and stable growth well over inflation rates, over the last three years.
SGOL Three Year Growth Chart (Source: Trading View)
Real estate is another traditional hedge. It’s the perennially safe bet that always holds value and generates gains in the long term. It’s also worth noting that this perennially safe bet got a boost from institutional investors in 2022, showing that high-profile investors believe in real estate long term. Bullish moves from big investors make real estate an even more attractive asset for long-term retirement savers.
It’s not all roses in real estate either, however. With interest rates set to rise, even this conventionally safe hedge has lost some of its allure. Still, it’s always come around in the long-term, and, it has multiple special benefits due to its unique position in the market.
What do these and other inflation hedges have in common? Effective inflation hedges generally hold similar properties, whether gold, silver, real estate, or commodities. A good hedge against inflation is:
- Stable – Gold, silver, and real estate are all perennial earners with long track records of stable growth.
- Scarce – Assets that hold value relative to inflating fiat currencies are generally assets that are characterized by natural scarcity.
- Insulated – Good hedges resist the economic fallouts of inflation and subsequent interest hikes. Gold and silver and, to a lesser extent, real estate, maintain value in times of instability. While they may not show overly exciting gains, these assets are usually able to weather the storm during extended periods of quantitative easing.
The new player is digital assets. Remember, this is the first time inflation has been a real issue since these assets came on the scene. Does the simultaneous existence of both inflation and cryptocurrency at the same time present new opportunities for inflation hedging?
Digital Assets and Inflation Hedging
Since their arrival digital assets have consistently outperformed fiat currencies. Whether it’s their freedom from centralized oversight, their anonymity, their liquidity, or their hard caps, there’s a real demand for cryptocurrencies.
A 2021 report from JPMorgan noted that investors are turning to Bitcoin as the new stable inflation hedge, and predicted the digital currency would reach a price of $146,000 per coin if it became the newly established safe-haven asset. And JP Morgan isn’t the only one noting the change.
Canadian investor Kevin O’Leary said that by the end of 2021 his portfolio would have 7% crypto exposure and only 5% gold. Dawn Fitzpatrick, George Soros’ fund head manager, recently revealed that the Soros fund had also cautiously moved into the crypto market.
One reason these assets might be growing as an inflation hedge is their characteristic scarcity. All major digital currencies, including Bitcoin (BTC) and Ethereum (ETH), are limited in supply. Bitcoin is capped at 21 million coins, 80% of which have already been mined. Ethereum does not have a hard cap like Bitcoin, but developers have slowly been clamping down on mining in order to minimize energy use and limit supply.
This built-in scarcity gives Bitcoin gold-like characteristics.
Here’s a visual of Bitcoin’s performance over the last three years compared to gold.
BTC-GOLD Comparison (Source: Trading View)
If Bitcoin is the new gold, Ethereum is the new silver. At least that is how Deutsche Bank described the two coins’ relationship in a 2021 report. ETH is the world’s second-largest cryptocurrency by volume and is poised to rise alongside Bitcoin as the clear second choice for investors in the crypto sphere.
Over the next two years Ethereum is releasing an update called ETH 2.0 which will solve existing concerns about scalability and energy consumption, making the coin more energy-efficient, more secure and, the developers hope, more valuable. ETH 2.0 will definitely make mining the coin more difficult, which will increase scarcity.
ETH and BTC Comparison (Source: Trading View)
Other cryptos may have specific allure, like Cardano (ADA), which markets its low energy usage as a unique perk. However, since there are now thousands of digital currencies, it’s easy to get into the weeds with the specific risks and benefits associated with more obscure coins.
So, if these assets are here to stay, how do they shape up against what we’re looking for as an inflation hedge?
- Stable – volatility has been one main descriptor for digital currencies since their appearance on the stage in 2009. However, with more cautious institutional investors moving into the market and backing from two sovereign states, these coins have achieved at least a minimum stability threshold.
- Scarce – the major cryptos are characterized by built-in scarcity that makes them ideal candidates for inflation hedging.
- Insulated – cryptos are highly insulated from monetary policy. Their value comes in part from their decentralized nature and their independence.
Given these characteristics, digital assets like BTC and ETH look like solid options for inflation hedging.
Crypto Strategies
It’s important to carefully consider your level of exposure and the risk you want to take on. Digital assets continue to hold relatively higher risk than other hedges like gold, real estate, and commodities. We’ve witnessed a positive trend of crypto inclusion in investor portfolios over the last four years, and higher inflation rates will likely drive this up, but digital assets are still relatively volatile.
Conservative portfolios hover around the 5-7% range while those more open to risk might go up to 15%. So if you are going to use digital assets to hedge rising inflation, make sure to balance the risk. It bears repeating that safe investing with cryptocurrency means that you don’t overexpose yourself to their volatility. Therefore, adding digital assets to other traditional hedges in your portfolio can be profitable.
For those interested in indirect exposure to digital assets such as Bitcoin and Ethereum, there are some budding options available in the form of ETFs and mutual funds. These are actively managed funds that invest in cryptocurrencies and are seen as a risk-managed method of crypto investing. To learn more about these options, take a look at our post on Bitcoin ETFs.
Bottom Line: How Does Crypto Hold Up Against the Tried and True?
Bitcoin and other digital assets are by no means the only inflation hedges. Nevertheless, digital assets are well-positioned to take on a big role as we head into a period of continued high inflation. These assets present one more potential safe haven to retain buying power and keep your capital from depreciating.
To get started with digital assets, check out our cryptocurrency investing guide. The guide explains some of the basics for crypto investing and contains some useful knowledge about using your IRA, 401k, or other tax-advantaged retirement savings account.
Mark Turner is an author and editor at Sophisticated Investor. He has over two decades of experience in the financial industry as a broker in both Chicago and New York and has written for several top tier publications. He currently covers the topics of alternative investments, geopolitical events, US economy, portfolio diversification and others.
