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Is Bitcoin an Effective Bet Against Inflation?

Billionaire Paul Tudor Jones once predicted that bitcoin would be a workable inflation hedge, but is it really?

Prices everywhere are constantly rising, and it’s hard for everyone to keep up.

Just last week, the US Federal Reserve raised interest rates by 0.25% – surprisingly after a swathe of US institutional banking meltdowns. This increase puts interest rates between 4.75% and 5%, and is the ninth increase of this year. But why is the Fed doing this?

In raising interest rates, the Fed hopes to battle inflation while also taking care of the huge changes going in the banking sector. However, the economy is already struggling enough, with many investors and economists scrutinizing the Fed that it may prolong economic turmoil.

Fed Chair Jerome Powell said strong economic data justified the hike, but acknowledged tighter credit conditions could further negatively impact households, businesses and the economy. As such, these tighter conditions produced by the Fed can create a slowdown in the economy. 

But can these measures put by the Fed can reverse inflation rates back to the target rate of 2%?

After the series of US recessions in the 1980s, a number of analysts and economists believe that inflation can be effectively prevented by increasing the federal funds rate to amounts more than the rate of inflation over a sustained period of time.

Today, inflation rates are at 6% (as of February 2023), while the federal fund rate is between 4.75% and 5%. As further interest rate increases are on the horizon, investors are expecting a tightening of the economy soon – and it’s about to be pretty severe, after the recent unraveling of the fragility of the US banking system.

While now the US Treasury Department and the Fed have publicly maintained the stance that they will adhere to the “too big to fail” principle – where they will rescue banks suffering from outflows that the Federal Deposit Insurance Corporation (FDIC) won’t, critics have reacted that this action can result in a “money-printing spree”, which will lead to further inflation.

As people are scrambling to find financial solutions to keep a hold of their assets in trying times, many are turning to bitcoin as a hedge against inflation. The logic is simple: if the fiat money system fails, then bitcoin will rise.

Paul Tudor Jones on bitcoin

Bitcoin hedgers regard an investor letter by American billionaire and hedge fund investor Paul Tudor Jones in response to the 2020 US government money printing efforts caused by COVID-19 as the most rational case to hedge a portfolio against inflation with bitcoin.

In the letter, Tudor Jones lists nine inflation hedges – “a host of assets that at one time or another have worked well in reflationary periods,” – from the most basic sorts (gold), to more esoteric ones (foreign exchange trading pairs). Out of the nine includes bitcoin, which he calls “the most established cryptocurrency.”

In analysing bitcoin’s effectiveness as an inflation hedge, Tudor Jones provides four criteria to assess each asset by:

  1. Purchasing power: How does this asset retain its value over time?
  2. Trustworthiness: How is it perceived through time and universally as a store of value?
  3. Liquidity: How quickly can the asset be monetized into a transactional currency?
  4. Portability: Can you geographically move this asset if you had to for an unforeseen reason?

In conclusion, Tudor Jones’ analysis leads him to identify bitcoin as the top candidate as an inflation hedge. Bitcoin can retain purchasing power, as it, at the time of writing, was the best-performing institutional asset in consideration of its lifetime. Bitcoin is trustworthy through cryptographic technology, as things are made secure – and more. Bitcoin also provides liquidity as it’s tradeable 24/7. And last but not least, bitcoin proves to be the most portable of the hedges listed in his analysis, due to being on a peer-to-peer system, and that no external entities can intermediate transactions on the blockchain.

But is this advice really worth following?

Then, what’s the best inflation hedge?

As Tudor Jones puts it:

“At the end of the day, the best profit-maximising strategy is to own the fastest horse. Just own the best performer and not get wed to an intellectual side that might leave you weeping in the performance dust because you thought you were smarter than the market. If I am forced to forecast, my bet is it will be bitcoin.”

While many are eager to switch to bitcoin today as the run on Silicon Valley Bank highlighted how digital finance, with the power of social media, can easily make or break a bank, it’s worth noting that these same features can also appear in the crypto market, as it’s similarly easy to make transactions digitally.

However, bitcoin does provide a fairly appealing safety net. It’s the currency of choice for many people living in countries and jurisdictions with economic and political uncertainty. As it’s digitally portable, many can still have access to their wealth across borders, unlike with other commodity assets or securities.

As bitcoin’s price is largely determined by consumer sentiment, it’s usually ruled out as a volatile asset. However, bitcoin has a chance at being an even more effective hedge against inflation  – once its own price volatility smooths out over time.

Regardless, if you do choose to use bitcoin as an investment strategy, only invest with amounts you’re prepared to lose. As it’s an investment for the long run, it’s also better to stick with a firm strategy for bitcoin, and other investments you might want to consider during times of inflation.

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