Although Bitcoin (BTC), which is down more than 30% from its record high at $69,000, has emerged as one the most profitable financial assets in 2021. BTC has outperformed the S&P 500, the benchmark US index, and gold.
Arcane Research’s new report noted that Bitcoin’s year to date performance was nearly 73%. The S&P 500 index soared 28% and gold fell by 7% during the same period. This is the third consecutive year in which Bitcoin has outperformed them both.
Bitcoin vs. S&P500 vs. Gold in 2021 Source: Arcane Research, TradingView
Higher inflation was at the heart of Bitcoin’s wildly bullish performance. This November saw the largest 12-month increase in U.S. consumer prices index (CPI), in over four decades.
The Arcane report stated that “most economists didn’t see high inflation coming,” as evidenced by 1-year ahead consumer inflation predictions.
“Bitcoin has been a great inflation hedge with its 73% increase in the highly inflationary year 2021.”
Inflation 2021: Actual CPI and Expected CPI. Source: BLS, New York Fed
Institutional investment vehicles saw an increase in Bitcoin holdings
Mainstream financial houses were also motivated by loose monetary policies and the constant fear of higher inflation to launch crypto-enabled investment vehicle for their wealthy clients in 2021.
Arcane reported a 140,000 BTC inflow ($6.56 trillion) across spot-, future-based Bitcoin exchange traded funds (ETF), and physically backed exchange traded products this year.
Bitcoin exchange-traded funds holdings Source: ByteTree, Arcane Research
This led to a rise in the number of Bitcoin units being absorbed by investment vehicles, indicating a higher institutional demand for the cryptocurrency.
According to the World Gold Council report, $8.8 billion was withdrawn from gold-backed ETFs in 2021.
Global gold-backed ETF flows. Source: World Gold Council
Superior performance is due to volatility
However, Bitcoin’s relative superior performance in 2021 included periods of high volatility.
Many analysts believe extreme price fluctuations prevent Bitcoin from being an effective inflation hedge. Leonard Kostovetsky from Boston College is one of those analysts. He wrote in a blog post that 13 days have passed since BTC’s price moved more than 10% in one direction. He wrote:
It seems odd to believe that someone who is concerned about holding dollars since they lost 7% over the past year would be happy holding Bitcoin, which can (and often does!) lose that much in one day.
Arcane also recognized Bitcoin as being more volatile than S&P 500 in 2021. He noted that Bitcoin behaved like a risk-on investment by amplifying stock market movements.
To illustrate the relationship between Bitcoin stock markets and Bitcoin, the researcher used VIX, which is a measure that measures the expectation of volatility using S&P 500 index options. The researcher noted that BTC’s value fell sharply when VIX readings rose in recent years, indicating that institutional traders considered Bitcoin a risk-on asset.
Bitcoin vs. VIX. Source: Arcane Research, TradingView
This means that Bitcoin’s risk of falling harder after a correction in the stock market is higher. Arcane noted that a bearish 2022 S&P 500 could wipe out a large portion of Bitcoin’s gains.
It added that “Be aware of the potential impact on bitcoin’s short-term price trajectory and stock market headwinds over the next year.”
Related: Arcane Research publishes its 2022 crypto predictions
Chris Brown, Aristides Capital’s managing director, predicted a complete Bitcoin doom for 2022. According to Brown, cryptocurrencies may face massive selloffs as the U.S. Federal Reserve’s $120-billion-a month asset-purchasing program is ended. This will be followed by three rate increases next year.
BTC/USD weekly chart vs. Federal Reserve balance sheets. Source: TradingView
Brown stated that if the Fed raises rates enough to make money significantly less looser, or if markets believe it will, certain areas of speculation may come to an abrupt halt.
“Crypto is the best example of asset speculation; there lies $2.64 trillion worth of ‘wealth.’ It is not backed by anything and generates no cash flow. You should do your research before making any investment or trading decision.