Is Inflation Bullish Or Bearish For Bitcoin?

Bitcoin has two inflation problems: the rising price of goods and services and the proliferation of alternative digital currencies.

The first type of inflation, let us call it "main street inflation," is supposed to be a boon for digital currency. Inflation undermines the value of national currencies, not the digital currency, which serves as a hedge against inflation. At least in theory, that is what bitcoin bulls think.

Divi Labs CEO Nick Saponaro is one of them. "Inflation works in favor of bitcoin's narrative because it is a mathematically sound store of value," Saponaro said. "Its deflationary nature is regulated by code, not humans. As people awaken to the debasement of their hard-earned fiat by the powerful decision-making authority of the few, they will turn to alternatives to preserve their money. Bitcoin solves this better than any asset class ever has."

Nevertheless, this theory does not seem to be confirmed by reality. Inflation has been rising at an annual rate of around 7% in the U.S. in recent months, but bitcoin has lost nearly 50% of its value from its November high against the dollar, 15% last week alone.

Sure, bitcoin bulls can blame the big governments of China, India, and Russia for that, but the disconnect between inflation and digital currency is too strong to ignore.

Apparently, something else is in play, like the end of the easy money by central banks to fight inflation. Moreover, that has steered investors away from risky assets, like technology stocks and cryptocurrencies.

"The limited supply of bitcoin is seen by many as a hedge against inflation, especially after the global money presses kept on printing," said Nicholas Cawley a strategist at DailyFX. "Bitcoin, with its 21 million maximum supply, has a natural advantage against the potentially unlimited supply of U.S. dollars, so its use as a hedge against inflation is worthy of discussion, especially as interest rates are set to rise. However, what we have seen over the past few weeks is bitcoin acting as a risk-proxy, with the price of bitcoin falling with other risk assets as the Fed readies itself to start tightening monetary policy by hiking interest rates."

That could explain why "bitcoin is not acting as an inflation hedge as higher inflation leads to expectations of higher interest rates and a lower bitcoin price," Cawley said.

Simply put, main street inflation is bearish, not bullish for the digital currency.

Meanwhile, bitcoin is facing pressure from the proliferation of alternative currencies. Let us call it cryptocurrency inflation. According to Statista.com, the number of digital currencies has soared from a handful in 2013 to more than 6,000 in 2021.

Furthermore, that makes the premise of a limited bitcoin supply irrelevant for its price movements.

Simply put, altcoin inflation is bearish for bitcoin, too. However, not everyone agrees with this position.

CoinLoan CEO Alex Faliushin is one of them. He thinks that the proliferation of cryptocurrencies is a positive rather than a negative development for bitcoin.

"The more people that gravitate towards the crypto sector, the more the industry will benefit, and crypto companies will expand," Faliushin said. "The entire market has pushed for innovation, and investors can now use crypto for more than just trading. Companies have offerings such as loans against crypto and high-interest savings accounts, both of which allow for bitcoin to be used, as well as other cryptocurrencies."

Mark Grabowski, author of "Cryptocurrencies: A Primer on Digital Money," is on the same page with Faliushin.

"I think, ultimately, altcoins help Bitcoin's value. Investing in cryptocurrency is a bit like dating," Grabowski said. "With thousands of alternative cryptocurrencies, it can be overwhelming trying to sort through them and choose which is best. Bitcoin is a reliable option that you can always depend on to be there. That may seem boring but, after dealing with enough bad altcoins, investors really grow to appreciate bitcoin and go running back to it."

That does not seem to be the case lately, as altcoins are falling in sympathy with bitcoin. However, the situation may change at any moment, given the volatility of the cryptocurrency markets.

Only time can tell whether inflation is bullish or bearish for bitcoin.