Bitcoin’s fixed supply. Ethereum’s growing utility. The borderless nature of digital assets. There’s no shortage of theory. But what does the data say? And how should institutional investors respond?
Let’s take a clear-eyed look at crypto and inflation: what’s hype, what holds promise, and how to build smarter portfolios in today’s economic climate.
What makes an asset a hedge against inflation?
Inflation hedges do one thing: help you preserve purchasing power. Traditionally, investors have looked to assets like:
- Gold: Scarce, tangible, and trusted across centuries.
- Real estate: Often appreciates with inflation and generates income.
- Commodities: Track inflation more directly, but can be volatile.
So, where does crypto fit in?
The case for Bitcoin as a hedge
Bitcoin is capped at 21 million coins ever. That’s fundamentally different from fiat currencies, which central banks can print in unlimited quantities. For many investors, this makes Bitcoin appealing as a digital store of value.
Unlike gold or real estate, crypto isn’t tied to a country or central authority. It’s designed to resist inflationary monetary policies, making it attractive in periods of currency devaluation or policy uncertainty.
From hedge funds to family offices, institutional players are adding crypto to portfolios. Why? Not just to chase returns, but to diversify and hedge against systemic financial risk.
Crypto isn’t just borderless. It’s programmable, liquid, and available 24/7. In regions facing inflation crises (like Argentina or Turkey), crypto isn’t theory; it’s a practical financial tool.
The case for Bitcoin as a hedge | Image by Brian J. Tromp
Where the theory meets reality
Still, crypto isn’t a perfect hedge. And it’s not immune to macro trends. Let’s break down how it’s actually performed.
Crypto can be volatile, sometimes dramatically so. Bitcoin surged to nearly $69,000 in November 2021 amid rising inflation, then fell over 60% by the end of 2022 as interest rates climbed. That kind of drawdown overshadows its inflation-protection narrative in the short term.
Over longer periods, patterns emerge. Bitcoin often performs well in environments with loose monetary policy and rising inflation expectations. But it also tends to move with other risk assets, especially tech stocks, during tightening cycles.
Figure 1: Bitcoin often moves ahead of inflation, but not always in lockstep. This chart shows how BTC price trends have, at times, anticipated changes in inflation (orange) and Fed rates (blue), particularly in 2020–2021. While not a perfect predictor, Bitcoin’s movements may reflect early investor sentiment about monetary policy and purchasing power. For forward-looking portfolios, that signal matters.
Crypto’s short history and evolving correlation to other markets mean it’s not a direct substitute for gold or bonds, but it may serve as a complement in a diversified hedge strategy.
Yahoo Finance reported in 2024 that both gold and Bitcoin saw renewed interest as inflation fears persisted, suggesting that over longer time horizons, crypto might still hold value. Forbes also highlights that, unlike gold, which has thousands of years of history, crypto is still maturing as an asset class. Its volatility may reflect growing pains rather than a fundamental flaw.
Institutional adoption: A vote of confidence?
Institutional engagement has grown significantly, with hedge funds, asset managers, and publicly traded companies like MicroStrategy actively allocating treasury reserves into Bitcoin.
- BlackRock, the world’s largest asset manager, now offers spot Bitcoin exposure to clients.
- MicroStrategy has made Bitcoin a core treasury asset.
- Hedge funds are experimenting with dynamic crypto allocations based on macro indicators.
As institutional adoption grows, crypto markets are becoming more responsive to broader economic policy. When central banks raise interest rates or tighten monetary policy, we often see digital asset prices react. So while crypto can help hedge inflation, it’s still influenced by the tools used to fight it.
Strategic asset allocation: Incorporating crypto into portfolios
You don’t need to go all-in. Most institutional investors are taking measured steps, such as:
- 1–5% allocation: Enough to diversify, without outsized volatility.
- Tactical adjustments: Increase exposure in times of high inflation or loose policy; reduce in risk-off periods.
- On-chain vs. off-chain mix: Use liquid crypto exposure (e.g., BTC, ETH) alongside tokenized real-world assets for balance.
Impact of passive BTC exposure on a 70/30 portfolio*
Figure 2: Small Allocation, Significant Impact: Incorporating even a modest BTC exposure into a traditional 70/30 portfolio can enhance returns and improve diversification, leveraging its low correlation and high return potential.Period of analysis: 31-Dec-2019 - 28-Feb-2025 Performance metrics based on monthly returns. *) Portfolio assumes 70% S&P Global BMI TR and 30% S&P U.S. Aggregate Bond TR, proportionally scaled to include BTC allocation (e.g., 70/30 + 10% BTC = 63% equities, 27% bonds, 10% BTC). Source: Google Finance, S&P
Final take: Is crypto a hedge against inflation?
Yes, but with nuance.
Crypto is a new kind of hedge, not a traditional one. It may not move in lockstep with inflation rates. But it offers something no other asset does: programmable, decentralized, globally accessible scarcity.
For investors seeking new ways to preserve wealth, crypto deserves serious consideration, especially as part of a well-diversified, forward-looking portfolio.
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The full breakdown
In our first article, "Navigating Crypto Volatility: The Advantages of Active Management," we explored how the high volatility and low correlation of digital assets with traditional asset classes create unique opportunities for active managers. We discussed how these characteristics enable active managers to execute tactical trading strategies, capitalizing on short-term price movements and market inefficiencies. Building on that foundation, we now turn our attention to the unique market microstructure of digital assets.
Conducive market microstructure of digital assets
The market microstructure of digital assets - a framework that defines how crypto trades are conducted, including order execution, price formation, and market interactions - sets the stage for active management to thrive. This unique ecosystem, characterized by its continuous trading hours, diverse trading venues, and substantial market liquidity, offers several advantages for active management, providing a fertile ground for sophisticated investment strategies.
24/7/365 market access
One of the defining characteristics of digital asset markets is their continuous, round-the-clock operation.
Unlike traditional financial markets that operate within specific hours, cryptocurrency markets are open 24 hours a day, seven days a week, all year round. This continuous trading capability is particularly advantageous for active managers for several reasons:
- Immediate response to market events: Unlike traditional markets that close after regular trading hours, digital asset markets allow managers to react immediately to breaking news or events that could impact asset prices. For instance, if a significant economic policy change occurs over the weekend, managers can adjust their positions in real-time without waiting for markets to open.
- Managing volatility: Continuous trading provides more opportunities to capitalize on price movements and volatility. Active managers can take advantage of this by implementing strategies such as short-term trading or hedging to mitigate risks and lock in gains whenever market conditions change. For instance, if there’s a sudden drop in the price of Bitcoin, managers can quickly sell their holdings to minimize losses or buy in to capitalize on the lower prices.
Variety of trading venues
The proliferation and variety of trading venues is another crucial element of the digital asset market structure. The extensive landscape of over 200 centralized exchanges (CEX) and more than 500 decentralized exchanges (DEX) offers a wide array of platforms for cryptocurrency trading. This diversity is beneficial for active managers in several ways:
- Risk management and diversification: By spreading trades across various exchanges, active managers can mitigate counterparty risk associated with any single platform. Additionally, the ability to trade on both CEX and DEX platforms allows managers to diversify their strategies, incorporating different levels of decentralization, regulatory environments, and security features.
- Arbitrage opportunities: Different venues often exhibit price discrepancies, presenting arbitrage opportunities. For example, managers can buy an asset on one exchange at a lower price and sell it on another where the price is higher, thus generating risk-free profits.
- Access to diverse liquidity pools: Multiple trading venues provide access to diverse liquidity pools, ensuring that managers can execute large trades without significantly impacting the market price.
Spot and derivatives markets (Variety of instruments)
The seamless integration of spot and derivatives markets within the digital asset space presents a considerable advantage for active managers. With substantial liquidity in both markets, they can implement sophisticated trading strategies and manage risk more effectively.
For instance, as of August 8 2024, Bitcoin (BTC) boasts a daily spot trading volume of $40.44 billion and an open interest in futures of $27.75 billion. Additionally, derivatives such as futures, options, and perpetual contracts enable managers to hedge positions, leverage trades, and employ complex strategies that can amplify returns.
Overall, the benefits for active managers include:
- Hedging and risk management: Derivatives offer a powerful tool for hedging against unfavorable price movements, enabling more efficient risk management. For instance, a manager holding a substantial amount of Bitcoin in the spot market can use Bitcoin futures contracts to safeguard against potential price drops, thereby enhancing risk control.
- Access to leverage: Managers can use derivatives to leverage their positions, amplifying potential returns while maintaining control over risk exposure. For instance, by employing options, a manager can gain exposure to an underlying asset with only a fraction of the capital needed for a direct spot purchase, thereby enabling more capital-efficient investment strategies.
- Strategic flexibility: By integrating spot and derivatives markets, managers can implement sophisticated strategies designed to capitalize on diverse market conditions. For instance, they may engage in volatility selling, where options are sold to generate income from market volatility, regardless of price direction. Additionally, managers can leverage favorable funding rates in perpetual futures markets to enhance yield generation. Basis trading, another strategy, involves taking offsetting positions in spot and futures markets to profit from price differentials, enabling returns that are independent of market movements.
Exploiting market inefficiencies
Digital asset markets, being relatively nascent, are less efficient compared to traditional financial markets. These inefficiencies arise from various factors, including regulatory differences, market segmentation, and varying levels of market maturity. For example:
- Pricing anomalies: Phenomena like the "Kimchi premium," where cryptocurrency prices in South Korea trade at a premium compared to other markets, create arbitrage opportunities. Managers can exploit these by buying assets in one market and selling them in another at a higher price.
- Exploiting mispricings: Active managers can identify and capitalize on mispricings caused by market inefficiencies, using strategies such as statistical arbitrage and mean reversion.
The unique aspects of the digital asset market structure create an exceptionally conducive environment for active management. Continuous trading hours and diverse venues provide the flexibility to react quickly to market changes, ensuring timely execution of trades. The availability of both spot and derivatives markets supports a wide range of sophisticated trading strategies, from hedging to leveraging positions. Market inefficiencies and pricing anomalies offer numerous opportunities for generating alpha, making active management particularly effective in the digital asset space. Furthermore, the ability to hedge and manage risk through derivatives, along with exploiting uncorrelated performance, enhances portfolio resilience and stability.
In our next article, we'll delve into the various techniques active managers employ in the digital asset markets, showcasing real-world use cases.
