Purchasing power: how BTC and gold hedge against currency depreciation

Even though fiat currencies are the most common medium of exchange, they have flaws, primarily losing value due to the effects of inflation, which reduces their purchasing power. This article explores why some people turn to hard assets like gold and bitcoin to hedge against these flaws.

Understanding purchasing power

Purchasing power measures the amount of goods or services a unit of currency can buy at a given time. It’s closely linked with inflation because when prices rise, it falls and vice versa. That’s why a consumer price index (CPI), which tracks the change in the average price of a basket of consumer goods, is a useful indicator of both inflation and purchasing power.

To demonstrate how purchasing power has fallen over time, take a standard consumer product like a loaf of bread. The UK’s Office for National Statistics has been tracking the price of an 800-gram loaf of sliced white bread since January 1971.

Interest rates also impact purchasing power because they’re the main tool used by central banks to manage inflation. Most set a target of around 2%, increasing rates if it rises above this level and cutting them if it falls below. This policy aims to maintain stable prices and, indirectly, a currency’s purchasing power.

Challenges facing fiat currencies

Research by CoinShares published in early 2024 explored why fiat currencies are deteriorating, based on economic data sourced for the previous two years from the top five countries by bitcoin adoption.

The Lebanese pound ranks as the world’s weakest currency against the dollar due to an economic crisis caused mainly by overborrowing to rebuild the country after its civil war between 1975 and 1990. The crisis climaxed in 2019 when banks had to shut their doors because they lacked sufficient funds to meet withdrawals, and the government defaulted on its debts. Inflation peaked at 268% in April 2023 (although it has fallen to 16% as of January 2025).

For context, the US dollar is the most dominant fiat currency, involved in nearly 90% of foreign exchange transactions. It has earned this status for several reasons:

• The Bretton Woods Agreement, concluded in the aftermath of World War Two, pegged global currencies to the dollar. While the agreement collapsed in the early 1970s, the dollar continues to dominate foreign reserves, held by countries to use for international transactions.

• The US economy is the world’s largest, accounting for over a quarter of global gross domestic product, which measures the value of goods and services produced within a country’s borders.

The US also has the strongest military. It spent just short of a trillion dollars on defence in 2024, nearly four times as much as China, the country with the second highest expenditure. 

Why hard assets are a hedge against fiat

People tend to turn to hard assets, such as gold and bitcoin, to hedge against the deterioration of fiat currencies because they maintain their purchasing power. For the same reason, they serve as safe havens during periods of economic or geopolitical instability. 

Gold has traditionally been the most popular ‘store of value’ due to several of its properties.

While rising prices erode the value of fiat currencies, the properties listed above mean gold is more resilient. For instance, as US inflation neared its covid-fuelled peak in March 2022 (8.5%), its price surpassed $2,000 per ounce, the highest level since August 2020.

Gold’s status in the global financial system is reflected in the strength of its long-term performance against the US dollar.

Bitcoin shares many of these properties, giving rise to the ‘digital gold’ narrative. In fact, bitcoin is arguably a more effective store of value in some respects, given its smallest denomination is a Satoshi (0.00000001 BTC) and holders can store it in a digital wallet.

Final words

To sum up, hard assets like gold and bitcoin offer an effective hedge as fiat currencies deteriorate because they retain their purchasing power. 

However, as with all asset classes, it’s important to remember that past performance doesn’t guarantee future returns.