Inflation and Bitcoin correlations

How can inflation affect the price of bitcoins? The correlation between Bitcoin and inflation is intriguing because it is not as simple as it seems. When interest rates are low, risky financial instruments rise because investors have a higher risk appetite.

Bitcoins are a risky and volatile asset, so they should go up when inflation is low. But this correlation doesn’t easily apply to cryptocurrencies. At the same time, the rule is certainly valuable for the stock market.

I will only analyze bitcoins, not the whole cryptocurrency market. I think that lately, it’s important to distinguish between the price of bitcoins and other cryptos. Ethereum could have a totally different history than bitcoin because of reasons we’ll go into more deeply.

Unlike other cryptocurrencies, bitcoin is mined and has a cost associated with it. Inflation will lead to higher prices for mining equipment. The increased inflation associated with a reduction in IT components will drive up the costs of mining bitcoins. As mining costs increase, the price of bitcoin could rise like any other commodity, but with many distinctions to make.

Bitcoin is not a raw material; it’s not used industrially, is useless, and is only a cryptocurrency. You can use other cryptocurrencies to make transactions. Bitcoin isn’t essential, like silver or copper. An increase in production costs doesn’t lead to an increase in prices because it’s not a commodity.

The price of chips will rise in the coming months for a few reasons, including inflation. A lot of analysts agree with this prediction. If the price of chips goes up, it’ll cost more to mine bitcoins.

Bitcoin and rising interest rates

When inflation rises, interest rates tend to rise. This is important for bitcoins for various reasons, which we’ll get into in this paragraph.

In the past few years, the US bond market wasn’t offering enough yield. Basically, it was the central banks that bought up all the government bonds.

10 Year Treasury Rate and inflation - 54 Year Historical Chart
Chart from Macrotrends.net

The most important thing about Bitcoin is that it doesn’t generate a monthly income. Cryptocurrencies can multiply your investment in a short time, but you can lose everything just as quickly.

Unlike T-bond, bitcoin doesn’t give you a guarantee on your investment and a monthly income. I considered the same thing when I compared physical gold to the t-bond during a financial crisis.

Interest rates on US government bonds have been falling for many years, but the US government’s huge debt accumulated in recent months should drive yields higher. The bond yield depends on the debt-to-GDP ratio. Debt is rising fast, and rising prices could cause an economic downturn that would shrink the economy.

The only way to keep interest rates low is if central banks buy a lot. Inflation would get out of control if they kept injecting money into the economy. How are we going to get out of this without raising interest rates?

When interest rates rise, US bonds become attractive because they are very safe and pay a monthly income. US bond interest rates are expected to rise due to the debt following the Covid crisis and inflation.

Many investors, after making huge gains on bitcoin, may decide to cash out and buy t-bonds. If the bitcoin market were to dump its liquidity into the T-Bond market, the price of bitcoin would collapse. Investors often act on impulse when it comes to cryptocurrencies.

Supply and demand affect the bitcoin market like any other market. If many investors sell, the price will decrease, and the movements will be much more violent in the cryptocurrency market. Volatility is affected by several factors; poor liquidity’s sometimes the biggest factor in cryptocurrencies.

Climate change, inflation and Bitcoin

Climate change and the de-carbonization of our planet will lead to rational energy consumption. Energy prices might arise during the transition to clean energy. Mining bitcoin uses a ton of energy, which will affect the price.

It’s clear how much energy bitcoin mining uses. This could also make mining more expensive, which could have a positive impact on the price. I have already told you that bitcoin is not a commodity and is not industrially needed, so an increase in extraction costs does not necessarily increase the price.

Estimates for bitcoin's electricity consumption chart
Image from BBC.com

On top of that, there’s another problem, which is related to the cost of mining. The transition to clean energies requires a lot of rare minerals.

The scarcity of these resources will raise the prices of rare minerals used to make chips. Then the price of the chips would go up, even more, making bitcoin mining even more expensive.

Inflation in the computer component sector could be very high because of the scarcity of rare minerals. Extracting rare minerals is very complicated and can further damage the environment, as in deep-sea mining.

The debate about bitcoin mining’s impact on the environment is growing. Some environmentally conscious investors might decide to sell their position in this cryptocurrency.

Governments and big companies are all focused on limiting greenhouse gas emissions. If bitcoin hurts the environment, it could lose popularity and become worthless.

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