November 17, 2023
Greg Cipolaro

Research Weekly - Inflation and the Turkey Investment Thesis


  • As inflationary fears recede into the rearview mirror, we look at what the data says about the philosophical debate about bitcoin and inflation.
  • We think that bitcoin continues to be driven by idiosyncratic factors, thus offering diversifying benefits to its holders.
  • With the continued rally in spot, a measure of market exuberance returns.

Inflation Perplexes Bitcoin, Prognosticators Alike

The Bureau of Labor Statistics released the October CPI numbers on Wednesday, revealing a surprising decrease in inflation that exceeded economists' expectations. This unexpected development led to a surge in equity markets, which continued to rally throughout the day. Initially, bitcoin also experienced a jump in value, but unfortunately, this excitement was short-lived as its price began to decline, even as equities remained strong. As the market celebrates the decline of inflation and anticipates a “soft landing” engineered by Fed Chairman Jay Powell, it is important to delve into the topic of inflation and its impact on bitcoin.

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Defining Inflation

To begin with, it is important to establish a clear definition of "inflation" as this term can have various interpretations in the digital asset industry. In economic terms, inflation refers to the measurement of the cost of goods and services, often represented by a year-over-year change. However, we can also think of this statistic from a different angle, where it becomes a measurement of purchasing power. Consequently, the Federal Reserve's long-term 2% inflation target can be seen as a target of a 2% annual decline in purchasing power. During times of peak inflation, consumer purchasing power experienced a significant annual decrease of 6% (core measurement) and over 9% when accounting for food and fuel costs. Essentially, this means that the value of US dollars decreased by 6% compared to the previous year, which has been a major concern for consumers.

Market analysts often refer to the concept of "devaluation" when discussing currencies, which signifies a sudden and significant decrease in their purchasing power. In contrast, inflation has a more insidious long-term effect, though this differs in hyperinflationary economies such as Argentina, Zimbabwe, or Venezuela, where their currencies are literally losing value by the second. In these cases, bitcoin is most certainly a hedge against loss of purchasing power.

Since inflation reached its peak in 2022, we have entered a "disinflationary" era - a period characterized by a gradual decrease in inflation. This doesn't imply that goods and services are becoming cheaper or that our purchasing power is increasing. Rather, it signifies that the rate at which our purchasing power is declining is decelerating. While goods and services are still pricier than they were a year ago, the pace of that price hike has slowed down.

Shortcoming Associated with Inflationary Measures

The measurement of inflation is a topic that often sparks public debate. In the United States, government agencies like the Bureau of Labor Statistics (BLS) provide monthly reports on the Consumer Price Index (CPI), which gauges the prices paid by consumers for a representative selection of goods and services. It also produces the Producer's Price Index (PPI), which measures the selling prices of domestic producers. The Bureau of Economic Analysis (BEA) offers the Personal Consumption Expenditures (PCE) Index, considered the preferred inflationary measure by the Federal Reserve. Additionally, various Federal Reserve Banks across the country generate their own inflation measures. Other alternative or private market inflationary measures, such as PriceStats (formerly known as the Billion Prices Project), also exist. It is not uncommon for market commentators to argue that these measures underestimate true inflation, claiming that the actual figure is higher. While it is true that these measures have their limitations, they provide a broad perspective. However, it is important to note that everyone's “personal inflation rate” will differ depending on factors such as their location, spending habits, and stage of life. As a personal anecdote, I recently experienced a staggering 13% increase in my rent in NYC, making the recent lower-than-expected CPI print of little relevance or comfort.

Inflationary Hedges

Real assets, such as precious metals, commodities, real estate, land, and other natural resources, have long been perceived as a traditional safeguard against inflation. Gold, revered by civilizations throughout history across the globe, has proven its resilience during the inflationary period in the US during the 1970s and early 1980s. Equities have also gained recognition as inflation hedges, thanks to corporations' ability to adjust prices for goods and services, which defines inflation. Additionally, Treasury Inflation Protected Securities (TIPS) can shield investors from the effects of inflation.

It would make sense then that a non-sovereign issued (not issued by any one country’s central bank) store of value like bitcoin, one with many same principles as gold, would be viewed as inflation hedge. Indeed, many investors prior to 2021 viewed bitcoin as an inflation hedge, albeit without much supporting evidence, aside from currency devaluations in specific geographies, like Cyprus in 2013. We like to think that bitcoin has many advantages to gold (divisibility, portability, transmissibility, storage costs, fixed supply) but with two main disadvantages to gold, longevity and social recognition.

Bitcoin – Inflationary or Deflationary Hedge?

Throughout the lifespan of bitcoin, it has often been referred to as a "deflationary asset," which can be somewhat perplexing considering the widely accepted economic definition of deflation as a decrease in the price of goods or services. From what we can gather, this term is likely referring to the limited supply of bitcoins, with a well-known cap of 21 million. Currently, the supply of bitcoins is growing at a rate of approximately 1.7% per year, but this will decrease by 50% to 0.85% annually in April during the next reward halving event. However, it is important to note that the supply of bitcoins is still expanding every 10 minutes on average. On the other hand, there is a counteracting factor in the form of coins that are permanently taken out of circulation due to lost private keys or becoming unspendable because of certain technical circumstances. If the number of these coins outweighs the number of new bitcoins being created, the available supply could decrease. It is crucial to understand that this discussion pertains to the supply of bitcoins and not the price level in economics.

One other way that bitcoin might be considered a “deflationary asset” is through price appreciation. As a theoretical example, imagine some goods that cost $100 when bitcoin is trading at $100. Those goods would therefore cost 1 bitcoin. Now imagine the same goods at $100, but bitcoin has appreciated to $1,000. Now those goods cost 0.1 bitcoins. Bitcoin could appreciate from the standpoint that more economic value is being transacted upon or stored in bitcoin, necessitating a rise in price given the zero-elasticity supply function. This would be considered a deflationary economic condition, if viewed from the standpoint of bitcoin as a unit of account or medium exchange (substituting from the US dollar standpoint).

When it comes to deflationary economic conditions, they are indeed quite rare. Apart from the end of the Global Financial Crisis in 2009, where headline CPI briefly turned negative (although the core remained positive), and the Great Depression, there have been very few instances of deflationary periods in the US. These conditions are essentially detrimental to the economy, resulting from market and economic instability. The impact of deflation is that assets such as cash and cash-like investments, bonds, and dividend paying stocks tend to perform well, unlike during inflationary periods.

Doublethink and the Turkey Investment Thesis

We cannot predict how bitcoin would perform in a deflationary environment. However, if one believes that inflation is beneficial for bitcoin, it is only logical to assume that the opposite is not true. This is why this comment from money manager Cathie Wood, stating that bitcoin is both an inflationary and deflationary hedge, seems to be contradictory. It is not logical to always consider bitcoin as the solution for every economic condition – tantamount to the “turkey turkey turkey” response to the investment question at hand. If this notion is true, then the important implication is that economic condition itself does not really matter. We have argued that bitcoin's idiosyncratic factors are more significant than macro/systematic factors. Hence, in the context of inflation/deflation, a more nuanced perspective, if one were to embrace the Orwellian doublethink mindset, would be that bitcoin simply does not correlate to inflation/deflation. This conclusion is supported by analytical analysis, which lacks statistical significance (t-stat) and explanatory ability (R Squared) for time frames longer than one year.

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What is even more fascinating than bitcoin's lack of correlation with inflation readings is its connection with inflation expectations. The 5-year breakeven inflation rates provide a market-based approach for gauging inflation expectations over the next 5 years. This approach is based on the yield differential between 5-year constant maturity Treasuries and 5-year constant maturity Treasury Inflation Protected Securities (TIPS). It holds much greater promise in terms of statistical significance and explanatory power compared to contemporaneous measures of inflation. However, it is important not to assign too much weight to this alone, as it does not encompass all major macro factors. Nonetheless, it provides some context as to why bitcoin did not perform well in 2022 despite peak inflation readings in the US.

Idiosyncratic Drivers Likely Still More Important – Halving Coming Up

Returning to our perspective on idiosyncratic factors, the influence of bitcoin's price cycles and halvings surpasses any systematic factors. In this context, 2022, along with 2018 and 2014, was simply a drawdown year of the recurring four-year price cycles, with little connection to inflation. This is advantageous for investors because bitcoin, primarily driven by factors unique to the asset itself, exhibits minimal correlation with traditional asset classes, thus offering diversification benefits that mitigate portfolio risks. Furthermore, the upcoming reward halvings, like the one coming next April, serve as checkpoint for price cycles. These halvings have historically marked the halfway point between price cycle peaks. In other words, if historical patterns repeat, this cycle still has significant legs.

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Futures Basis Rallies Along with Spot

The CME futures basis, the premium that futures contracts trade over spot as measured on 1-month rolling annualized percentage, recently reached levels not seen since the last cycle high. This is an important gauge of market sentiment as futures are a popular way to express market views with leverage. And the CME being a regulated US market, highlights the positioning by US traders. Offshore trading venues for futures, such as Deribit, show a positive basis, but not nearly the same magnitude as the US.

The gross basis (not inclusive of funding costs) closed at 24.7% last Tuesday and remains well in the high teens. At the end of November 2021, just after the launch of the ProShares Bitcoin Strategy ETF, which invests in CME listed futures, closed at 39.6%. This a marked change from a year ago when the basis was steeply negative in the wake of the FTX induced sell off, which took spot price to nearly $15K and the basis to below -40%.

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This ramp in the basis comes as both futures open interest and daily volume continue to grow. The CME has now surpassed Binance in terms of open interest ($4.3B vs $4.1B), yet still trails it in terms of daily trading volume ($2.7B vs $19.0B). This discrepancy in open interest and volume highlights an important difference about trading behavior between US institutional investors on the CME and the offshore traders dominated by Binance, with the implication of much heavier turnover for traders on Binance than on the CME.

Market Update

Weekly Markets-Nov-17-2023-07-18-13-7430-PM

Bitcoin fell 1.7% on the week, but still held close to the $36K price level. Little news developed on the closely watched ETF front, aside from a delay in the decision for the Hashdex Bitcoin ETF. While it appears as though the SEC and issuers continue to work behind the scenes, including news that issuers are being asked to switch from in-kind creation/redemptions to cash, there are few deadlines until January of significant consequence. Equities markets loved the inflation print and the mantra of an economic “soft landing” as the S&P 500 was up 3.6% and the Nasdaq Composite was up 4.5%. Bonds also cheered the inflation data as investment grade corporate bonds rose 2.4%, high yield corporate bonds rose 1.2%, and long term US Treasuries rose 2.4%. Gold rose 0.9% despite the declining inflation backdrop, while oil continued to correct, down 3.7% on the week.

Important News This Week


The BTC Options Market Is Bigger Than Its Futures Market - CoinDesk

Cboe Digital to Launch Margined Bitcoin and Ether Futures - Cboe

Echoes of Bitcoin 2021 Record Run Emerge in Derivatives Market - Bloomberg

Regulation and Taxation:

SEC Announces Enforcement Results for Fiscal Year 2023 - SEC

IOSCO Finalizes its Policy Recommendations for Crypto and Digital Asset Markets - IOSCO

Dubai’s Top Crypto Official Set to Leave, Regulator Plans Fines - Bloomberg

Guidance Regarding Listing of Virtual Currencies - NY DFS


Stablecoin Issuer Tether Wants to Become a Major Bitcoin Miner - Bloomberg

Stablecoin USDC’s Slide Makes Circle’s Proposed IPO a Hard Sell - Bloomberg

Announcing Buy Bitcoin Globally - Strike

CoinShares Secures Strategic Option to Acquire Valkyrie Funds - CoinShares

Upcoming Events

Nov 24 - CME expiry

Dec 13 - FOMC interest rate decision

Jan 10 - Final ETF decision deadline for the first bitcoin ETF, ARK 21Shares

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