S&P Global, a leading rating agency, recently acknowledged the potential of cryptocurrencies as a hedge against inflation. The New York-based agency stated that crypto assets could theoretically protect investors from the effects of inflation, especially in emerging markets where inflation is high. However, S&P Global also pointed out that there is a lack of data to support this popular narrative. The agency drew attention to the weak correlation between bitcoin and U.S. inflation expectations, emphasizing that the track record for crypto is too short to prove that it can serve as a store of value.
Crypto proponents believe that bitcoin, the largest digital asset by market value, can act as a store of value asset like gold. This is due to a programmed code that halves bitcoin’s pace of supply expansion every four years, which contradicts the ever-increasing fiat money supply globally. The broader crypto market, including decentralized finance (DeFi), is seen as an alternative to a centralized fiat banking system. However, S&P Global’s findings show that there is little association between the crypto market and inflation expectations.
S&P Global’s crypto index, S&P BDMI, has a historical correlation of just 0.10 with U.S. two-year and 10-year breakeven inflation expectations. The correlation between the rolling three-month returns for S&P BDMI and 10-year breakeven inflation expectations shows no conclusive pattern. A strong correlation of at least 0.75 might be needed to validate the inflation hedge narrative. Breakeven inflation rates are measures of investors’ expectations for inflation over a specific period derived by subtracting the yield on inflation-protected bonds from the yield on nominal bonds.
Despite the lack of correlation between the crypto market and inflation expectations, crypto assets seem to be sensitive to the cost of borrowing in the economy. They tend to move in the opposite direction of the U.S. two-year Treasury yield, which is more susceptible to interest rate expectations than longer duration bond yields. S&P Global’s chart shows an inverse relationship between the two.
Gold, on the other hand, has consistently tracked inflation expectations since 2013. S&P Global noted that there is evidence of Granger Causality between the 10-year Breakeven Inflation Expectation index and the S&P GSCI Gold index at a 95% confidence level. The Granger Causality test is a statistical hypothesis test for determining whether time series X is helpful in forecasting Y. However, the same test fails for Bitcoin.
Last year, bitcoin’s market value tanked by over 70% even though inflation in the U.S., as measured by the consumer price index, averaged 8%. The rolling three-month returns between the two show no conclusive pattern. S&P Global’s chart shows several periods where an increase in inflation expectations has failed to lift crypto market valuations. There have been periods when the two were simultaneously positive or negative.
In conclusion, S&P Global’s analysis suggests that while cryptocurrencies may have potential as a hedge against inflation, there is a lack of data to support this narrative. The weak correlation between the crypto market and inflation expectations indicates that cryptocurrencies cannot yet be considered a reliable store of value asset. However, crypto assets seem to be sensitive to the cost of borrowing in the economy and tend to move in the opposite direction of the U.S. two-year Treasury yield.
