Inflation. Rising energy prices. Shortages of everyday essentials. No matter where you live, the highest level of inflation since the 1980s is here, rearing its ugly head in the global economy. “Perfect! Irresponsible governments finally get what they deserve for printing so much money,” you tell yourself, as you own what many influencers and investors have called the perfect inflation hedge: Bitcoin, a supply-limited cryptocurrency with a predictably low inflation schedule, free from the meddling hands of central bank monetary policy. But, wait — now that we are seven months into the year, you find that Bitcoin has lost 41% of its value year-over-year and 58% since January 1st. So, were the influencers right? In this article, we aim to find out as we analyse how different asset classes have performed historically amidst high inflation, so that we may get an idea of how other supply-limited but risky assets such as NFTs can perform in this environment.
Inflation and returns data since 1928 were collected for US Treasuries, the SP500, gold and real estate. Additionally, annual returns data since 2010 was collected for Bitcoin. The time series of this data can be seen below in the graph, but please take note that returns for Bitcoin had to be cut off at 200% for the sake of preserving the other data.
Since 1928, US Treasury returns have a correlation coefficient of -0.086 with inflation, SP500 returns have a 0.022 correlation coefficient with inflation, gold returns have a 0.328 correlation coefficient with inflation, and real estate returns have a 0.549 correlation coefficient with inflation. Since 2010, Bitcoin has a -0.1 correlation coefficient with inflation. Correlation coefficients range from -1 to 1, and in this case, a correlation coefficient of 1 would mean that for every 1 unit of increase in inflation percentage, there would be an equal 1 unit increase in percentage returns of the asset.
So, what does all of that actually mean? Well, for starters, it means that real estate returns are more strongly correlated with inflation than any other asset class, but is only moderately positively correlated to inflation in general. This makes sense given the truly supply-limited constraints of real estate; property developers aren’t creating any more land (we will choose to ignore artificial islands in this case). Gold, another supply-limited asset, also has a low positive correlation to inflation.
Digging into US Treasuries, the stock market (SP500), and Bitcoin, however, and the picture becomes less clear. All three of these asset classes showed negligible correlation with inflation, with the absolute value of their coefficients all being below 0.3. This points us to the conclusion that something else other than inflation is the driver for returns of these asset classes. In this light, it is important to understand context. For example, in 2008, it was the real estate market itself that went haywire and subsequently sent stock markets returns into the gutter, gold returns higher and, inevitably, led to the very creation of Bitcoin itself. Similarly, the United States has not experienced actual deflation since 1954, almost 70 years ago, so it’s hard to say what a truly deflationary environment would look like for modern financial markets today.
Nevertheless, that something, the special sauce, can simply be chalked up to “sentiment”. Not sentiment like the fear and greed index, but rather the overall investor sentiment about what the future of the world will look like. After all, any classically trained economist will tell you that it is actually inflation expectations, not an expansion of the money supply, that leads to increases in inflation. For example, the likelihood of investors to purchase gold over Bitcoin has increased over the past decade, which means that at the margins, Bitcoin’s performance would be relatively higher. Sentiment may also help to explain why stock market returns are not more positively correlated with inflation, as investors sell these highly liquid investments out of fear, only to see trailing 12-month returns after a high inflation print turn mostly positive.
Financial markets are extremely complex mathematical systems that either reflect the unique perspectives of each individual market participant, or tell us absolutely nothing at all — depending on who you ask. We do know a few things about NFTs, though. Each discrete NFT collection is extremely supply-limited, with maybe only a couple thousand NFTs available in each collection, whereas the entire NFT market as a whole is vastly inflationary, with new collections getting released every day. So, similar to something like fine art, there are likely to be pockets of demand for certain pieces of art, but not art in general during an inflationary period where investors may be looking for ways to scale back their spending. Something else about NFTs is that much like real estate, a unique buyer and seller must come together and agree upon a price; there is no prevailing market rate that you are guaranteed to get if you would like to sell, and there are also significant transaction fees associated with these transactions, charged by the brokerages that bring together buyers and sellers.
In closing, NFTs share many characteristics with supply-limited assets such as real estate, gold, and Bitcoin, yet are also unique in their own special ways. More data needs to be collected about the NFT market in aggregate, as well as for individual collections, before a real, long-term correlation can be seen. Preliminarily, however, NFT market performance in an inflationary environment — where almost every financial asset on the planet is going down in tandem — has not been as poor as many NFT haters would have you believe.
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