Why Bitcoin Could Be a Big Winner if More Inflation Happens

The U.S. is not reliving the high-inflation period of the 1970s, but prices are still rising faster than the Federal Reserve (and consumers, and investors) would like. If inflation flares again in the next few years, and it probably will, investors will be looking for assets that are harder to dilute than cash.

Bitcoin (CRYPTO: BTC) is near the top of that list of assets. Here's how it could benefit from rising inflation, and how to use it in your portfolio without overrelying on it.

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Scarcity and locked-up supply are hard to beat

Inflation especially hurts assets that depend on policymakers to maintain their value. Holding liquid fiat currency is the ultimate example, as policymakers can opt to reduce its value outright by printing more money or by making money very inexpensive to borrow. Investors therefore look for assets that will either outgrow inflation or which cannot be expanded at will, like real estate or gold.

Bitcoin was built to become a member of that second category. Its protocol caps total supply at 21 million coins, and more than 94% of that sum is already mined. That leaves relatively little new issuance, especially after the most recent halving of mining rewards, and even less issuance expected in the future once the next halvings occur.

On top of that, there are 3 million to 4 million coins, up to roughly 20% of the eventual total that can exist, which are lost because people misplaced keys or abandoned their crypto wallets. In practical terms, that implies closer to 17 million to 18 million coins that can ever trade, and the ownership of that quantity is also concentrating in slower-moving hands than ever before.

A bloc of financial institutions and corporate entities, as well as digital asset treasuries, already hold more than 6 million BTC, around 28% of the eventual total. Spot Bitcoin exchange-traded funds (ETFs), which buy and hold coins on behalf of investors, add another layer of locked-up supply, as asset managers need to hold the coin to issue ETFs in the first place.

If inflation accelerates again and more investors want exposure to a non-fiat store of value, a modest jump in demand will be pushing against a relatively small pool of coins that are actually for sale. That setup tends to produce outsize price moves over time.

This hedge isn't perfect

None of this makes Bitcoin into the ideal inflation hedge.

One big problem is simply that it doesn't have a long track record compared to some of the other leading candidates for the role. Gold has a history of being a store of value that stretches back thousands of years, with ample evidence that it preserves purchasing power through many inflationary eras, and even through civilizations. Bitcoin's history spans a handful of monetary cycles, and much of that period was dominated by booms and crashes.

Nonetheless, Bitcoin's returns have tended to rise after positive inflation surprises, which supports the idea that it can act as a partial hedge. The catch is volatility; Bitcoin has repeatedly lost 40% to 80% of its value in past downturns even when inflation stayed positive, which is not ideal if you may need to tap your hedge on short notice.

If the next inflation flare-up comes bundled with a recession or financial stress, investors could easily sell Bitcoin alongside stocks to raise cash. Of course, that's true of gold or real estate too, but investors should appreciate that it's considerably easier to liquidate a Bitcoin position than it is to sell a house or a gold bar.

The best approach here is thus to treat Bitcoin as one component of an inflation-resistant portfolio, which also includes more proven assets. If inflation does become stickier, Bitcoin's scarcity and growing institutional footprint give it a real shot at being one of the biggest winners. If it doesn't, having a small position won't derail your broader strategy.

Alex Carchidi has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.