S&P Global, one of the world’s leading credit rating agencies, has recently released a statement that shed light on the popular narrative regarding cryptocurrencies as an inflation hedge. While the agency acknowledged the potential of crypto assets as a store of value, it also emphasized the lack of data to support this claim.
Theoretical Basis for Crypto as an Inflation Hedge
Many proponents of cryptocurrencies believe that these digital assets could be a hedge against inflation. They argue that in a high-interest rates/high inflation environment, crypto assets could serve as a store of value. This narrative is supported by the fact that some emerging markets battling high inflation have adopted cryptocurrencies.
Moreover, Bitcoin, the world’s largest digital asset by market value, is often considered a store of value asset like gold. This is because of the programmed code that halves Bitcoin’s pace of supply expansion every four years. The so-called mining reward halving contradicts the ever-increased fiat money supply globally, making the broader crypto market, including decentralized finance (DeFi), an alternative to a centralized fiat banking system.
However, S&P Global’s findings suggest that past data does not support this narrative.
Lack of Data to Support Inflation Hedge Narrative
According to S&P Global, the historical correlation between the daily returns of its crypto index, S&P BDMI, and the U.S. two-year and 10-year breakeven inflation expectations is just 0.10. The correlation between the rolling three-month returns for S&P BDMI and 10-year breakeven inflation expectations shows no conclusive pattern.
In other words, there is little connection between the crypto market and inflation expectations. A strong correlation of at least 0.75 may be needed to validate the inflation hedge narrative.
Furthermore, the agency noted that Bitcoin’s market value dropped by over 70% last year in spite of inflation in the U.S., as measured by the consumer price index, averaged 8%, according to Statista.
In contrast, S&P Global found that gold’s daily returns have consistently tracked inflation expectations since 2013. The agency even noted evidence of Granger Causality between the 10-year Breakeven Inflation Expectation index and the S&P GSCI Gold index at a 95% confidence level. However, the same test fails for Bitcoin.
Sensitivity to Cost of Borrowing
While cryptocurrencies may not be an inflation hedge, they seem sensitive to the cost of borrowing in the economy. S&P Global found that cryptocurrencies tend to move in the opposite direction of the U.S. two-year Treasury yield, which is more susceptible to the interest rate expectations than longer-duration bond yields.
“On a daily rolling three-month basis, interest rates [two-year yield] and the crypto index have exhibited an inverse relationship 63% of the time since May 2017. This increases to 75% from May 2020, following the start of the COVID-19 pandemic,” S&P Global said.
The Bottom Line
While cryptocurrencies may have the theoretical potential to serve as an inflation hedge, the lack of data to support this narrative makes it difficult to validate. S&P Global’s findings suggest little association between the crypto market and inflation expectations. On the other hand, cryptocurrencies seem sensitive to the cost of borrowing in the economy.
This news has important implications for investors looking to diversify their portfolios. While cryptocurrencies may have unique advantages, they should not be seen as a substitute for traditional assets like gold with a proven track record as a store of value.
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