Highlights
Changes in Bitcoin Granger cause changes in the forward inflation rate.
A one-standard-deviation shock to Bitcoin results in a persistent increase in expected inflation.
The relation between Bitcoin and inflation is not driven by the pandemic.
This study examines the time-series relation between Bitcoin and forward inflation expectation rates. Using a vector autoregressive process, we find that changes in Bitcoin Granger cause changes in the forward inflation rate. Furthermore, imposing an exogenous shock to Bitcoin’s price results in a persistent increase in the forward inflation rate. Our findings provide support for the notion that Bitcoin may be used as a hedge against inflation as changes in the price of Bitcoin tend to lead changes in the expected inflation.
Introduction
The market capitalization for Bitcoin recently eclipsed a trillion dollars. Practitioners and some researchers have suggested that Bitcoin is a viable hedge against inflation. For instance, in May of 2020, Bloomberg News reported that hedge fund manager Paul Tudor Jones responded to concerns about the expansionary policy by many of the world’s central banks during the Covid-19 pandemic by purchasing Bitcoin.
Likewise, MicroStrategy Inc., the largest publicly traded business intelligence company, raised its holdings of Bitcoin in February of 2021 by about 20,000 coins because it believes the cryptocurrency to be a “dependable store of value”.2Unlike traditional currencies, Bitcoin has a fixed limit of 21 million coins and trades in a decentralized unregulated system. Schilling and Uhlig (2019) provide a theoretical overview of the interaction between Bitcoin and a more traditional currency that is supplied by a central bank. The authors allow the supply of Bitcoin to grow deterministically and show that Bitcoin can be considered a viable, albeit volatile medium of exchange.The strong demand for, limited supply of, and monetization of Bitcoin gives it the potential to protect against rising prices, which fits the definition of inflation hedge implied by Reilly et al. (1970) and Cagan (1974).
In contrast to the hedging arguments above, other economists have suggested that Bitcoin is simply a speculative investment that does not resemble anything like a traditional monetary instrument. In fact, the Federal Reserve Chairman, Jerome Powell, stated in March of 2021 that cryptocurrencies are “highly volatile and therefore not really useful stores of value… a speculative asset that is essentially a substitute for gold rather than for the dollar”. Baur et al. (2018) provide empirical evidence that Bitcoin is uncorrelated with traditional assets such as stocks, bonds, or commodities, suggesting it is mainly used as a speculative investment. Furthermore, Peetz and Mall (2017) argue that Bitcoin is not a transaction currency for a variety of reasons such as the difficulty to value, the lack of intrinsic worth, and its limited transaction capacity.
Given the conflicting opinions regarding Bitcoin as a potential inflation hedge, a structural analysis of both Bitcoin and expected inflation seems warranted. In this study, we conduct a variety of multivariate time-series tests to examine the lead–lag relation between Bitcoin and the Federal Reserve Bank of St. Louis 5-year forward inflation expectation rates. According to Branch (1974), Fama and MacBeth (1974), and Oudet (1973), a security is an inflation hedge if its returns are independent of the rate of inflation. As noted by Bodie (1976), such independence can be loosely defined as a positive correlation between the nominal rate of return on a particular asset and the rate of inflation.
Results from our multivariate time-series tests are striking. First, we find that changes in the price of Bitcoin Granger (1969) cause changes in the forward inflation rate. However, the opposite direction of causation is not observed. We then estimate a series of vector autoregressive (VAR) equations, where both changes in Bitcoin and changes in the forward inflation rate are treated endogenously. We impose an exogenous shock of the change in Bitcoin and estimate impulse response functions for changes in the forward inflation rate. Interestingly, accumulated impulse response functions become positive shortly after the exogenous stock to the change in Bitcoin. Moreover, the results are robust across the pre- and post-Covid periods and the inclusion of several different lags in the VAR framework.
Our findings provide general support for the idea that Bitcoin could be used as a viable hedge against inflation as its returns are not only positively correlated with the future inflation expectation rate, but tend to lead it. Thus, our results contribute to the broad literature that focuses on inflation hedging.
In particular, Narayan et al. (2019) show that the growth rate in Bitcoin is related to Indonesia’s monetary aggregates. Their empirical results suggest that, in the case of Indonesia, changes in Bitcoin are directly related to inflation. Our findings also tangentially contribute to the growing body of research regarding the efficiency of Bitcoin.The relation we find between Bitcoin and the forward inflation rate could stem from structural differences in the respective markets where these instruments trade or it could be an indication of where prices are being discovered.
Section snippets
Data description
The data used throughout the analysis are obtained from two primary sources. From CoinMarketCap, we gather daily prices in Bitcoin for the two-year period that ranges from January 1st, 2019 to December 31st, 2020. During this same period, we gather the 5-Year Forward Inflation Expectation Rate (T5YIFR) from the St. Louis Federal Reserve Bank. This rate is defined as follows:
We estimate both the likelihood ratio test and Akaike’s information criterion and determine that the appropriate number of lags in Eq. (3) falls between one and five. To determine the proper ordering of the above VAR model, we begin by estimating Granger
Conclusion
We find that changes in Bitcoin Granger cause changes in the forward inflation rate, but not vice-versa. We also find strong evidence that an unexpected increase in the price of Bitcoin is associated with a significant and persistent increase in the forward inflation rate. The findings in this paper have important implications for both investment managers and policymakers. First, our results suggest that Bitcoin can act as a hedge against expected inflation. This is important for investment
Declaration of Competing Interest
The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.
