Bitcoin Losing Support as 'Store of Value,' Inflation Looms Over Recovery

Gone: The idea that Bitcoin is a store of value.

The price of gold has risen as Bitcoin's value has plunged, underscoring a flight to safety amid rising inflation and a sharp downturn in the cryptocurrency market.

Critics, including New York investment bank Goldman Sachs, have long argued that Bitcoin is too volatile to be a store of value, but that's only part of the equation.

For swashbuckling long-term investors, Bitcoin remains a bet on future price appreciation. Some have bought the dip to expand their Bitcoin holdings at a good price.

On Sunday, Bitcoin fell to $31,772.43, nearly 51% below its all-time high.

A persistent downturn of 20% or more is generally considered a bear market.

Meanwhile, gold has risen 5.92% in the last 30 days, and climbed 1.20% Monday to $1,881.90 an ounce.

#28. James Dimon (JPMorgan Chase & Co.)
"The Bitcoin flow picture continues to deteriorate and is pointing to continued retrenchment by institutional investors," JPMorgan said in a research report. Pictured is Jamie Dimon, CEO of JP Morgan Chase & Co. World Economic Forum / Wikimedia Commons

But the price of Bitcoin, the world's largest cryptocurrency by market cap, rebounded in early trading Monday. Ethereum, the second largest crypto, also traded higher.

"It's true that some indicators seem to point to the possibility of a bear market, but in our view, this is more of a prolonged and overdue correction triggered by (Elon) Musk's tweet and the Chinese news creating a cascade effect in a significantly over-leveraged market," Jason Deane, Bitcoin Analyst at Quantum Economics in London told Newsweek.

But he argued that Bitcoin's long-term prospects remain bright.

"The way ahead in the short term is unclear," Deane said, "but Bitcoin's fundamentals, network and objectives remain entirely intact, meaning that holders with long-term objectives are likely to be unfazed."

Deane said a review of trading shows that no major institutional investors have sold as Bitcon's price fell.

"This broadly confirms that most coins are 'young'—only recently purchased—that are changing hands," Deane said. "This means the most recent purchases of Bitcoin are also the main sellers. This is a fairly typical pattern in a bull market correction where new investors have a higher propensity of panic selling through lack of understanding of the asset, markets and trading."

However, JP Morgan said institutional investors have pulled back from Bitcoin futures traded on the Chicago Mercantile Exchange.

"The Bitcoin flow picture continues to deteriorate and is pointing to continued retrenchment by institutional investors," JPMorgan said in a research note. "Over the past month, Bitcoin futures markets experienced their steepest and more sustained liquidation since the Bitcoin ascent started last October."

Nevertheless, the bank stood by its earlier estimate that Bitcoin could climb to a new high and exceed $140,000.

"This $140k price should be thought of as a long-term theoretical target assuming a convergence of Bitcoin volatility to that of gold and an equalization of Bitcoin allocations to that of gold in investor portfolios," the research note said.

Two major events caused the Bitcoin selloff: Musk said Tesla would no longer accept Bitcoin as payment for its electric cars and the People's Bank of China restated its ban on the use of cryptos for any type of payment.

China also clamped down on Bitcoin mining, citing its high energy usage.

But Beijing's stated concern probably shouldn't be taken at face value because China generates the majority of its electricity at coal-fired plants and continues to build new plants.

The reason: Coal-fired power plants are cheap to build and reliable. China's economy, second only to the U.S. in size, has lifted millions out of poverty.

"In 2019, coal made up 57.7% of China's energy use," ChinaPower, a division of Washington-based Center for Strategic and International Studies, said in a report. "China has consumed more coal than the rest of the world combined. China's industrial sector is by far the largest consumer of coal."

China's crackdown on Bitcoin mining almost certainly won't punch a hole in the market because after a short lull others will crack the hexadecimal puzzles and earn new coins as reward.

Deane said demand for new Bitcoin mining machines—computers used to solve the puzzles—remains strong and supply is tight due to the worldwide shortage of semiconductors.

Bitcoin mining operation
A worker walks through a Bitcoin mining facility in Saint Hyacinthe, Quebec, on March 19, 2018. Lars Hagberg/AFP/Getty

China's decision to ban Bitcoin mining could create a strong market for used machines, but it's not clear Beijing will allow such sales. Mining is necessary to maintain the blockchain, the unbreakable ledger of transactions underpinning the Bitcoin market.

The Federal Reserve, the nation's central bank, said it plans to issue a research paper this summer outlining the benefits and risks of issuing a U.S. digital currency. China has launched a digital yuan and is testing it in selected cities.

The argument: Governments will not give up their monopoly to issue and regulate money—and that could mean trouble ahead for Bitcoin and Ethereum, a crypto designed for commerce.

Unlike Bitcoin, or other cryptos, a Central Bank Digital Currency (CBDC) would be issued by the government, backed by monetary reserves, centralized and regulated.

Some see the Fed's proposal as a shotgun aimed at Bitcoin's gut, but Deane said government-backed digital currencies may strengthen Bitcoin.

"First, there is recognition from controlling bodies that digital payments are inevitable," he said. "Second, this will create a global normalization for using digital currencies and blur the line between a digital dollar, yuan or any other asset. Finally, this will enable much easier transition between digital assets since the format will be universal."

In the future, Deane said, people are likely to have a "multi-asset" digital wallet that allows "seamless and instant movement" between cryptos and government-issued CBDCs.

"It makes sense that in this scenario, Bitcoin, as a standalone non-sovereign, would be a compelling choice," he said.

In mid-day trading Monday, Bitcoin changed hands at $37,964.80, up 13.90% in the last 24 hours and up 31.36% for the year. The 24-hour range is $31,179.69 to $38,727.73 The all-time high is $64,829.14. The current market cap is $710.58 billion, CoinDesk reported.

Market Pulse

The U.S. economy leads the world in recovering from the COVID-19 pandemic, but the rebound comes at a steep price: Inflation.

The services sector, including restaurants, entertainment and travel, are strong and are likely to expand as vaccination rates increase and government lockdown restrictions ease.

IHS Markit Logo
"While the US saw the strongest expansion, it also reported by far the steepest increase in prices for goods and services," IHS Markit, a London-based provider of market information, said in a report. ihsmarkit.com

"While the US saw the strongest expansion, it also reported by far the steepest increase in prices for goods and services," IHS Markit, a London-based provider of market information, said in its Purchasing Managers Index (PMI) report.

IHS Market expects the U.S. gross domestic product, the value of all goods and services produced in a year, to grow 5.7% in 2021 and 4.1% in 2022.

But the lift from federal stimulus programs may be partially offset by rising long-term interest rates.

Earlier this month, the U.S. Labor Department said inflation increased at the fastest pace since September 2008. The Consumer Price Index (CPI), a measure of a basket of goods plus energy and housing costs, jumped 4.2% from a year ago.

Analysts surveyed by Dow Jones expected a 3.6% increase. The monthly increase was 0.8% compared with the anticipated 0.2%.

Excluding food and energy prices, which can be volatile, the core CPI rose 3% year-over-year and 0.9% on a monthly basis. Energy prices are up 25% from a year ago, including a 49.6% jump in gasoline prices.

The U.S. and the United Kingdom reported record expansion and the Eurozone reported the strongest expansion since February 2018, but growth in Australia is falling back from a record high and Japan lags, IHS Markit reported.

The Federal Reserve believes higher inflation will be "transitory." A member of the Board of Governors believes inflation will abate in 2023 after missing the central bank's 2% target this year and next.

IHS Markit said some higher prices can be attributed to kinks in the supply chain, a problem that will be gradually corrected.

"Some of the price pressures appear temporary," Chris Williamson, Chief Business Economist at IHS Markit, said in a report. "Companies have struggled to rebuild capacity not just in factories but also in sectors such as hospitality, citing shortages of inputs, staff and logistical support. How long these price pressures persist for will depend on how quickly supply and demand come back into balance."

The U.S. Bureau of Labor Statistics said employers added 266,000 jobs in April. Employment in the retail sector continues to grow, but it still has about 400,000 fewer workers than in February 2020, the month before the coronavirus pandemic struck and state governments ordered stores and restaurants to close as part of the effort to limit its spread.

Frank Breuss, co-founder of fintech company Nikulipe, said small and medium-sized enterprises should maintain the online presence developed during the pandemic to remain competitive as the economy reopens.

"There is a risk that many smaller merchants will go back to running only the physical stores, with a possibility of closing the e-stores they run now—but it would be a waste to neglect or even stop their e-commerce business, once life moves towards the normal pace again," he said in a note to Newsweek. "Maintaining the presence in the e-commerce space will allow them to access new, sustainable revenue streams, as well as better compete with the big e-commerce players like Amazon or eBay."

A survey by McKinsey & Company, a global management consulting firm based in Chicago, found that more than half of the shoppers worldwide plan to continue to purchase online and pick up the items at the store, a practice that emerged during the pandemic.

Through May 22, about 129 million Americans, or 38.9% of the population, have been fully vaccinated against COVID-19. About 60% have received the first shot, the U.S. Centers for Disease Control and Prevention reported.

Experts estimate that 70% to 90% of the population must be vaccinated to achieve herd immunity and curb spread of the coronavirus.