Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

YOU might think that 2022 is turning out just how bitcoin investors would have liked. The global economy is slowing, weighed down by persistent supply chain pressures, rising inflation and the prospect that interest rates are going to increase further and faster than almost anyone feared just a couple of months ago.

Bitcoin fundamentalists argue that bitcoin can’t be undone by central bank policies, because coins are mined and traded by huge numbers of unconnected individuals. That puts them beyond the reach of coordinated actions that might threaten their inherent value.

What’s more, bitcoin should, like gold, be resistant to inflation, owing to its limited supply. Bitcoin supply is algorithmically capped at 21 million coins, and over 90% of them are here already1.

So while inflation equates to a fall in the buying power of paper currencies like the dollar and the euro, the value of a bitcoin should stay relatively stable, all other things being equal. Add excess money printing into the equation, and bitcoin’s value should rise in paper money terms.

What we have seen, however, is a much more complicated picture forming. Bitcoin is down by about a quarter since it posted a record high at $69,000 last November, despite nothing fundamentally counting against it2.

Inflation has risen sharply and, while the Federal Reserve is proposing to shrink its balance sheet, central banks continue to print excess paper money overall.

What squares the circle is the fact that bitcoin has become a bit of a poster child for short term, speculative investors. Over recent months, its progress has borne an uncanny resemblance to the rises and falls traced out by America’s technology laden Nasdaq Index, itself a rough proxy for investor sentiment3.

That means bitcoin has tended to do well when investors have been most confident in the global financial system, not when they’ve been the most worried, which is the opposite of what we might have expected.

We’ve seen anomalies like this before with gold. For example, as the pandemic first took hold in March 2020, gold initially eschewed its safe-haven status by posting a big decline4. At the time, this was attributed to panic causing investors to sell their most liquid assets, irrespective of the fundamentals.

Positively, bitcoin’s 'hash rate' has recently risen to new highs, at over 200 terahashes per second5. Hash rate corresponds with the number of miners in operation, difficulty of confirming a transaction and, ultimately, the security of the network.

Moreover, bitcoin may well have an important role in helping to cushion investors from the effects of inflation over the longer run, not least because its annual rate of production falls by roughly 50% every four years. This puts bitcoin on an inexorable path towards greater scarcity that even gold can’t match.

However, there’s no denying the current link between bitcoin and big tech, even though theory suggests there shouldn’t really be one. We shouldn’t, therefore, expect the road to digital currency Nirvana to get any more smooth or predictable, or the need to diversify across multiple asset classes any less pressing.

Source:

1 Blockchain.com, 12.04.22
2 Reuters, 18.01.22
3 Bloomberg, 11.04.22
4 FT, 16.03.20
5 Blockchain.com, 12.04.22

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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