Inflationary recessions create monetary illusions.
Paulo Macro
G’day Folks,
I love this quote, and I have found myself thinking about it often. The concept that inflation can create illusions and divergences between what we see, and how we feel.
As you know, the behaviour and sentiment we see within Bitcoin onchain data is directly related to the way investors feel about the current environment. The more in profit or loss they are, the more likely they will do something about it.
In today’s piece, I want to explore this concept of inflationary illusions as it relates to the Bitcoin price. I believe it holds one of the keys to why this cycle feels very different to previous ones.
Through this process, I will also show you accounting for inflation can yield a more representative MVRV Ratio and drawdown metric which I think really speaks to how the Bitcoin price makes me feel right now.
Without further ado, let’s get into it.
Disclaimer: This article is general in nature, and is for informational, and entertainment purposes only, and it shall not be relied upon for any investment or financial decisions.
TL;DR
- Inflation is hard to think about, but it creates a very real divergence between what we see (prices) and how we feel (purchasing power).
- Around 60% of the inflation which has occurred over Bitcoins lifetime has happened since 2020, making this a prime example of inflationary divergences.
- If we adjust the Bitcoin price for today’s dollars, the 2021 ATH was actually $100k! Similarly, priced in 2020 dollars, the current spot price is closer to $35k.
- Personally, I found this exercise of thinking about, and adjusting for inflation helped me understand it better, and explains why a -26% drawdown…feels more like a -40% in real terms…
Sentiment Headwinds
This cycle does have unique characteristics, and in particular, I want to identify the three biggest headwinds I believe are affecting sentiment:
- Over-allocation to altcoins – I have heard from numerous sources, both retail and institutional, that a great many investors were caught off guard over the last 18-months. Many folks expected the classic capital waterfall (BTC—>ETH—>L1s—>Tokens), and underestimated the performance of BTC.
- Chopsolidation Boredom – Global markets have been working their way through all sorts of strange liquidity conditions, with higher rates, shifting treasury auctions, and frankly, market interference by the authorities. The choppy conditions are largely a result of this, and it is exhausting to say the least.
- Lost Purchasing Power – The incredible volume of money printed in 2020-21 has taken years to flow through, and be digested by the system. The result has been a depreciation of the purchasing power of every dollar, and that includes the purchasing power of assets that couldn’t keep up.
This final point is the one I want to focus on today, as the truth is, a $60k BTC in 2021 buys less stuff than a $60k BTC here in 2024.
In fact, if we take US CPI numbers at their word (more on this later), the USD lost 50% of its purchasing power since Bitcoin’s first traded price in 2010. around 60% of this inflation has occurred since 2020!
Inflation Adjusting Price and MVRV
Now we all know that the government issued CPI numbers are bogus, and can only be considered a lower bound. When they say inflation is 3%, the reality is it is more like 6%…or even 9%.
I don’t think there is much value in trying to nail down exactly how large the reality diverges from the official numbers. However, I think we can comfortably say that 2x to 3x is a minimum degree of under-reporting, and sufficient for this exercise.
To illustrate the dilutive impacts of inflation on our purchasing power, let’s anchor our inflation adjustment to today’s prices.
Q: What was the 2021 ATH priced in Sep-2024 dollars (assuming 3x CPI)?
A: $100k!
Another way to think about fiat dilution is to anchor to 1-Jan-2020, and price everything in pre-COVID dollars.
With the current spot BTC price trading at $55k, the CPI adjusted price would be closer to $45k. If we believe CPI is 2x or 3x under-reported, then the real price is $38k or $35k, respectively.
The purchasing power of a $55k BTC today, can only buy $35k worth of 2020 goods!
This is the perfect opportunity to introduce an idea that I will echo for the rest of this piece:
The spot price is what we ‘see’, but the real inflation-adjusted price is what we ‘feel’.
Notice in the chart above, I have shown two onchain price models:
- 🟣 Realised Price $31k – the average cost basis per unit of BTC.
- 🟢 True Market Mean Price $47k – the average cost basis per investor (filters out lost coins, Satoshi etc).
Since most people do not actively look at ‘inflation adjusted prices’, I believe it is suitable to measure these onchain price models directly, and no adjustment is needed.
As soon as we inflation adjust the spot price, notice how we’re actually trading below the True Market Mean! The purchasing power of everyone’s holdings is actually below their average cost basis, which no doubt dampens sentiment.
The sentiment, mood and behaviour of investors will be a result of the delta between their cost basis, and their perceived purchasing power. In other words, investors consciously, or unconsciously make decisions to buy or sell based on how their investment performs in real inflation-adjusted terms.
Using this logic, we can construct a ‘Real-MVRV Ratio’:
- What we see is a new ATH, and price trading above our average ‘cost basis’.
- What we feel is no new ATH, and price barely hovering above break-even…
The Hidden Tax
What makes inflation so insidious is that most people have no idea how to think about it, and it affects everyone. In many ways, inflation is a hidden tax, and a persistent headwind hurdle rate that we all must beat…just to break even.
What we see during this chopsolidation is a drawdown that is around -26% below the March ATH.
What we feel is a 40% drawdown below the 2021 ATH when priced in 2020 dollars. In purchasing power terms, we never made a new ATH which is probably why it feels so lacklustre.
Whilst Bitcoin investors have paid a -26% drawdown via the price, we have paid an additional -14% drawdown tax due to the debasement of our 2020 dollars.
Interestingly, the height of the 2019 echo-bubble also peaked at around 40% below the 2017 ATH. The suite of similarities between 2019 and today are numerous.
Closing Thoughts
Thinking about inflation is hard, and honestly, this is why governments and central banks prefer it to direct taxation. We don’t get to vote on it, it is persistent, far-reaching, and effective as a tool to extract wealth from everyone.
In real terms, Bitcoin never actually set a new ATH in March, and despite the tremendous inflationary headwinds, Bitcoin remains one of the few assets which is still ahead of it.
Just imagine what this analysis would look like for assets outside the big winners like Gold, Bitcoin and the Mag-7. I can’t imagine there is a long list of assets that are consistently outperforming the currency debasement we have experienced over the last four years.
For me personally, this analysis has helped me frame up why a -26% correction ‘feels like’ a -40% one…that’s exactly what it is in real purchasing power terms.
I also get the sense that a $55k BTC price is far more undervalued than people give it credit for. In fact, it is almost like I am looking at a $14k BTC back in 2019-20, which is still working its way back towards the last cycle ATH.
Inflationary illusions…
Thanks for reading,
James