Inflation and Crypto – A Detailed Analysis That Everyone Should Read

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Inflation and Crypto – A Detailed Analysis That Everyone Should Read

Inflation and Crypto - A Detailed Analysis That Everyone Should Read

Hi Y'all,

I wanted to update the deep dive with some more analysis and why inflation is coming

External analysis:

New Correlation:

Old Correlations:

My Analysis:

Historic S&P to BTE:

Data from St. Luis FED

As you can see below, for most of the recovery (March through November), the historic tie between S&P and BTC held at 84% of variance explained with a high degree of significance.

Diving Deeper, when we analyze the full YTD trend line we see a strange phenomenon, that historic ~84% variance model shifts dramatically in its explained variance. Doubling standard error, and reducing the R2 from 84% to 59%. The vast majority of this happens from November to March.

BTC Price to S&P Index

Given the historic tie between BTC and S&P, per Coinbase and Forbes, this needs to have a causality. Finding the causality, one needs to look for larger changes in the overall state of the economy and what Bitcoin means as an asset.

The macroeconomic theory Quantity of Money's equation: MV = PY, where M is money supply, V is money velocity (how often a dollar changes hands), P is average price per good, and Y is output (or real GDP) can be rewritten as M= PY/V or money supply equals PY(Nominal GDP) / Velocity of money.

Historically, in the short term, prices are sticky; meaning it takes time for average price of goods to reflect a change in the overall money supply. Compounding this, the money supply only affects inflation when velocity increases.

So going back to the quantity of money equation that the Fed uses, MV=PY, the Velocity of money has been depressed by the pandemic (people have been spending less). So we're waiting for post-Corona Inflation, where velocity returns to normal rates, putting all that money back into the economy. Prices in the short term are sticky, meaning that they are resistant to change, and that's where we're headed. Dollars are, in real terms, going to be worth less than previously, and by a lot.

So how much is a lot?

That's where you need to take into account what a dollar really is, which is a (mostly) non physical unit of account that, due to our system of fractional banking, can be in many places at once. This idea of a dollar existing in multiple place has a name, and its called the money multiplier. The money multiplier is how much "digital" money is out there in proportion to the monetary base (the amount of physical dollars). You get this by dividing the amount of money held in accounts and in reserves (money that banks are required to hold as collateral)

Seen here:

M1,M2,MB In Billions, Source:

So for every dollar printed, as of January 2021, 3.45 dollars are added to the money supply. Not that big of a deal if your printing a few dollars. So lets put it in perspective. How much money was printed?

Lets go back to the Fed to find out:

% Change in Money Printed by Year**

OECD, "Main Economic Indicators – complete database", Main Economic Indicators (database), (Accessed on 3/8/2021)

Digging into the data, from 2019 to 2020 you see a 34% jump in the money supply. To state that again, 34% of all money in circulation was printed within the past 12 months.

To put a number on it, as of January 1st, that was $1,307,858,333,333.33 that's 1.3 trillion physical dollars, but that's not it. To find the amount of non-physical dollars in the money supply, take that 1.3 trillion and multiply it by the money multiplier. As of January, every physical dollar introduced resulted in a sum of 3.45 physical and non physical dollars.

So why isnt everything 34% more expensive? The purchasing power of the dollar should be reduced because there's less of it, right? The answer is yes, and no. This is where "sticky" short term prices come in. So long as the velocity of money stays below average due to the pandemic, inflation is at bay.

– BUT –

That's temporary at best, macroeconomics show that in the long term, equilibrium will be met. A shift in the Monetary Supply, driven by the FED reducing interest rates for banks (allowing them to borrow for almost free), and purchasing Government bonds (with newly printed money), drives Aggregate demand up.

Money Supply and Aggregate Demand

Aggregate demand pushes prices up (in the long term), and increased prices (inflation, again long term). Resulting in the rebalance of prices and output to the new equilibrium.

So here we stand, the Fed has pumped money into the economy through purchasing bonds – increasing the money supply, but rather than spend the money, the average American is saving it. The Money supply = Nominal GDP/ Velocity hasn't caught up to the Fed's influx of cash. When it does, prices will shoot up to match the change in real purchasing power.

So what does that have to do with Crypto?

Capped cryptocurrency, unlike the USD, isn't subject to a regulating body that needs to fund itself. There is no loss to road maintenance, no loss to paying civilian employees, no loss to purchasing land, buildings, or warships; its a much more efficient unit of account. More importantly, unlike the USD, creating more crypto costs a exponentially greater amount of resources over time. Its more akin to Gold than it is to the USD.

People are not willing to buy US bonds due to fears of inflation, driving the bond market to increase the yield to entice people. The former bond holders, out of fear of increased inflation are flocking to alternative assets. Crypto has benefited from this phenomenon and is set to continue to benefit.

Seen here:

Data: St. Louis Fed

BTC to Bond Yield

We have a bumpy ride ahead, HODL.


The quantity theory states that the rate of money growth is directly proportionate to the rate of inflation. The Fisher Effect states that the rate of inflation is directly proportionate to the nominal interest rate (a .71 R value). The nominal interest rate is key because historically, bond prices have a negative correlation to nominal interest rates, meaning the higher the interest rate, the lower the bond sales, the lower the bond sales the higher the yield they need to offer.

The bond market is starting to move with Inflation, and rather than keep cash in bonds or USD, a currency that potentially lost 33% of its real value as more was printed, they flocked towards BTC and ETH; rather than slowing down, this pattern may speed up as we see the fed slow to react to inflation by reversing its stimulus policy.

The inflation that everyone is worried about is already happening, institutional investors have already begun switching to BTC over bonds. The real fun will happen when retail switches over en-mass and purchases smaller coins.

Bullish on (in order): ETH, BTC, DOT, & ADA

This is not investment advice.

***Edit: Thanks for the Platinum, silver, and hugz!! ***

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