Cryptocurrencies

Upcoming cryptocurrencies and inflation

Gold and Bitcoin: Similarities and Differences.

Bitcoin (Blue) and Gold (Red) price. Source: FRED

Two different assets.

In our previous article, we came back to the fact that gold and Bitcoin both have different market structures. [voir article]. Almost 75% of the gold supply depends directly on mining companies, while the influence of miners on Bitcoin’s supply tends to decrease sharply. In addition, Bitcoin is a very concentrated asset: 0.01% of agents hold 32% of Bitcoins in circulation, which is not the case with gold. On the other hand, the capitalization of the two markets is very different: cryptocurrencies represent 12% of the capitalization of the physical gold market.


As a result, the price reactions are very different. Bitcoin will react more strongly to times of stress. In addition, gold is an asset that can be stored with most agents. That is, a rise in the price of gold today is irreversible: much of the gold bought in jewelry or investment will not be sold in large quantities. Bitcoin is more volatile and therefore does not follow the same fundamental logic, although many investors keep the quantities purchased for a long time.

Thus, between March 2020 and August 2020, we saw a simultaneous rise in gold and Bitcoin. Nonetheless, with the recovery in Asia and America, gold corrected while Bitcoin set off a powerful bull rally. Recently, we are witnessing the reverse process of a powerful rebound in gold, and the drop in Bitcoin [retour de la volatilité].

Gold and Bitcoin: implicit correlation.

Bitcoin is an asset determined by market stress (volatility). Gold is an asset determined by real rates (rate less inflation). As the graph below shows, major spikes in financial stress (VIX, red curve) usually take effect after a decrease in real rates. Likewise, periods of low stress in the markets generally result in an upward stabilization of real rates. This confirms our first graphical comparison in gold and Bitcoin.

VIX volatility index (red) and real US 10-year rate (blue). Source: FRED.

Gold is favored by inflation, the fall in key rates, or the fall of currencies like the dollar. Put more simply, gold increases when the (net) return on capital decreases. The fact that gold is very sensitive to rates and that Bitcoin is very sensitive to tensions caused by rates allows us to highlight a fundamental correlation.

We could thus advance the fact that a rally on Bitcoin takes place initially with a simultaneous rise in gold, and secondly, Bitcoin increases more strongly than gold. Indeed, initially, gold and Bitcoin generally follow the same uptrend. This is due to falling real rates and financial stress. However, there comes a time when real rates rise again as the context is favorable for investment, causing gold to fall and Bitcoin to continue to rise. These very fundamental logics are the heart of the implicit link between Gold and Bitcoin.

Inflation: dynamics ahead.

A brief history of inflation.

Inflation (or deflation) is a fairly simple economic mechanism. When there is the formation of a gap between the quantities demanded or offered, there is a variation in prices. In other words, inflation exists during periods of tension between supply and demand. [voir livre]. The graph above shows the inflation rate in the United States since 1785. There are three major peaks of inflation: 1814, 1864, 1920, 1974. Each peak of very high inflation corresponds to the completion of a rise. prior to inflation over several years. Each peak of high inflation (1813, 1864…) is often characterized by the presence of a war: the Napoleonic war in 1813, the civil war in 1864, the first world war after 1920, the Vietnam war and the oil crisis in 1974.

These inflationary peaks can be explained in different ways:

  • War situations cause a breakdown in international trade and the productive apparatus, thus generating very inflationary drifts. The outbreak of war today would have unprecedented and absolutely disastrous effects on prices.
  • Inflationary contexts are often the result of strong monetary creation: the Greenbacks under the civil war, the rise in central balance sheets under the First World War, the end of the gold standard after 1971, etc.
  • Inflation manifests itself primarily in correlation with economic cycles. Periods of growth and prosperity necessarily cause a change in the balances between agents, which results in tensions and price volatility. We will recall the fabulous sentence of Clément Juglar: “You should therefore never despair or hope too much for your country, constantly reminding that the greatest prosperity and the greatest misery are sisters, and always follow one another. “.

An end to the disinflationary cycle!

Going back to the previous graph, we see ultra-inflationary regularities every 5 to 6 decades. On a shorter scale, we note the recurrence of cycles of 9 and 18 years. The following graph shows the application of these main inflationary cycles [voir article].

Source: Inflation: long-term cycle and coming dynamics | Economy – Thomas Andrieu (andrieuthomas.com)

The 2020 crisis marked as anticipated [voir livre 2019] the return of an inflation of shortages and a situation of stagflation (the GDP remains lower than 2019 with a rise in prices). This dynamic respects all or almost all of the cyclicality of inflation. Thus, we could see a continuation of an inflationary trend until 2025/2026, followed by a very likely peak between 2032 and 2036. This is the very nature of economic cycles and inflation.

Since 1981, we have been living in an economy with ever lower inflation (disinflation), which leads to a fall in rates and potential growth, as well as an increase in debt and unemployment. This balance is not sustainable 10 or 15 more years, simply because it causes social and civil tensions.

“Protecting yourself” from inflation: Gold or Bitcoin?

Bitcoin: pro-inflationary … but not too much …

Clearly, Bitcoin benefits from good inflation (generating growth and stability of real rates), but is heavily impacted by bad inflation (which causes pressure on rates …). It will be recalled that Bitcoin is an asset very sensitive to volatility. The support of 16 on the VIX in recent weeks was a clear negative signal for cryptocurrencies. Volatility depends directly on the evolution of rates, on which gold is also entirely dependent. It should be noted that more than 80% of bearish reversals in medium-term rates are followed by a correction on equities. Likewise, it should be noted that corrections on equities are generally preceded by a correction on cryptocurrencies. [voir article]. In short, Bitcoin protects against moderate inflation.

Bitcoin (blue) and inflation (red) prices. Source: FRED.

The graph above shows the correlation between inflation and Bitcoin. We can indeed observe that Bitcoin can globally benefit from a return in inflation, but this is not obvious at all times because of the stated processes.

Gold: bulwark against inflation.

Finally, gold reacts very strongly to inflation. In comparison, gold can go up while Bitcoin can go down, and vice versa. Great periods of financial stress often benefit gold first and then Bitcoin second.

In my book on gold, I notably came back to the fact that gold benefits from periods of economic stress, and therefore price volatility. The advantage of gold over Bitcoin is that it is more stable over time and is much more resistant to market stresses resulting from price movements.

Ultimately, cryptocurrencies are not devoid of links to inflation. Investors are flocking to digital assets en masse during times of influx of liquidity and inflation in the markets. However, the presence of inflation such as to increase rates too sharply or to reflect liquidity shortages implies a negative effect on the price of digital currencies. In short, Bitcoin is a bit of a digital gold, both too volatile and abstract to be completely tied to economic times, yet democratized enough to make it a full-fledged financial market.

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