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Can Bitcoin Cement its Position as a Hedging Instrument in the Midst of Economic Uncertainty?

Having money and money having value are two completely different things. Traditional currencies such as the US Dollar, Chinese Renminbi, Euro or Pound are all inflationary in nature due to the fact that central banks can print them whenever they want in whatever quantity they want. As a result, the money of today has more value than the money of tomorrow and significantly more value than the money of say, a year from now. Another factor that has weighed in on traditional currencies is the threat of market uncertainty. In the midst of economic turmoil or uncertainty in the financial markets, investors rush to move their investments into safe-haven assets to retain the value of those investments. 

Gold has remained one of the most popular, if not the most popular, safe-haven asset to which investors turn in uncertain times. However, the emergence of a new asset class in the last decade, in the form of cryptocurrencies, has not only offered another avenue for investors through which to diversify their portfolios, but has also led many to believe that Bitcoin is  “digital gold” and a good safe haven.

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Why has Bitcoin Been Touted as “Digital Gold”?

One of the main reasons why gold has been popular among investors as a hedging instrument against inflation or uncertainty is the fact that gold is a scarce and limited resource, a characteristic shared by Bitcoin. There can only ever be 21 million Bitcoins, not a single one more, essentially making the digital currency a deflationary one, whose purchasing power, theoretically, increases every day. In addition, Bitcoin has several characteristics that make it superior to gold.

Bitcoin can be held, moved and managed far more easily than gold. The fact that Bitcoin resides on the blockchain and not in the physical world, allows it to be transferred almost instantaneously across physical and geographical boundaries together with being spent in a more comfortable way than gold. 

However, the question remains: is this enough to make Bitcoin a good hedge against economic uncertainty and inflation?

Bitcoin Vs Gold: Is the Comparison Really Justified? 

We are no stranger to Bitcoin’s volatility. The price fluctuations that Bitcoin undergoes on a daily, weekly or even  yearly basis are factors that cannot be ignored, especially when we are looking to hedge our investments against them. Bitcoin traded at around $325 in early January, 2015 and remained somewhat stable for the next 12-15 months before receiving  more attention from the investor community. Since then, Bitcoin has experienced several periods of volatility. At the beginning of 2017, one Bitcoin was worth around $1,000, then by year end, it went up to nearly $20,000 before crashing down to $3,500 by the end of 2018. The Bitcoin bulls rallied again in 2019 and the price has fluctuated between $3,700 and $14,000. 

Source: Coinmarketcap.com

Gold, on the other hand, can be viewed as more stable if you compare it to Bitcoin. Safe-haven assets by definition are expected to be safe investments which retain their value and gold has most definitely proven its worth as a top store of value.

Proponents of gold cite Bitcoin’s volatility as one of the key reasons for rejecting the “Bitcoin as a safe haven” argument and naturally, the proponents of Bitcoin cite all the reasons that make it superior to gold, including the fact that it is not controlled by any one entity. 

Year Close %

change

1990 $386.20 -3.69%
1989 $401.00 -2.23%
1988 $410.15 -15.69%
1987 $486.50 24.46%
1986 $390.90 19.54%
1985 $327.00 6.17%
1984 $308.00 -18.95%
1983 $380.00 -14.99%
1982 $447.00 11.75%
1981 $400.00 -32.76%
1980 $594.90 29.61%
1979 $459.00 120.57%
1978 $208.10 29.17%
1977 $161.10 20.43% 
1976 $133.77 -3.96%
1975 $139.29 -24.20%
1974 $183.77 72.59%
1973 $106.48 66.79%
1972 $63.84 43.14%
1971 $44.60 14.65%
1970 $38.90 -5.12%

Source: Only Gold

Much of the gold we have come to love and trade today gained popularity in the 1970s, which only makes it a more reasonable time period in which to compare Bitcoin, since a comparison of today’s gold and Bitcoin would be like comparing a chicken and an egg. Clearly, the gold market is much more mature than the Bitcoin market.

If we look at Gold prices from the 1970s when it gained popularity, the annual percentage change does not seem different to Bitcoin’s today. Between 1970 and 1990, Gold also experienced huge fluctuations as Bitcoin does today, so arguing that Bitcoin is not a safe haven, because it is volatile, seems odd considering Bitcoin today is what gold was 30-40 years ago. 

Is Bitcoin Truly Gaining Prominence? An Empirical View

For the average investor, regardless of the time period of the comparison, this level of volatility can be a big, red flag. However, there are studies which show the contrary. In times of economic instability or uncertainty, investors’ appetite for cryptocurrencies, particularly Bitcoin, has increased.

Venezuela is a prime example of Bitcoin’s resilience as a store of value. As an economy rocked by hyperinflation and facing a dearth of food and medicines, Venezuela’s appetite for Bitcoin has not fallen short. The amount of Bitcoin traded in the oil-rich country soared by as much as 30 per cent in February this year to reach an all-time high (based on data provided by Coin Dance). The fact that people are willing to put their faith in cryptocurrency in what is most likely the worst humanitarian crisis the country has ever gone through, presents a very strong argument for Bitcoin.

Argentina is another country that finds itself in the grip of successive economic crises and yet where Bitcoin investing has become quite prominent. According to data from the local cryptocurrency exchange, Ripio, Bitcoin was seen to be trading at a premium as compared to the global average. In late October, during the crisis, Bitcoin was trading at ARS$633,862 ($10,578), while the price on Coinmarketcap was around $9,150. 

While one could argue that Bitcoin is a passing fad, historical data from recent years show otherwise. Based on a study conducted by Grayscale Investments, in which they assessed the correlation between buying Bitcoin and other assets during some of the key macroeconomic events of the past 5 years, they saw that Bitcoin largely outperformed the traditional markets and major currencies. 

During the stock market crash of 2015 in China, Bitcoin outperformed other markets, producing a cumulative return of 53.6% versus an average return of -10.1% across the rest.

Source: Grayscale Investment

Similarly, on 24th June, 2016,  when the Brexit referendum results were announced, the markets saw a one-day global sell-off in which Bitcoin still managed to remain resilient and posted a return of 7.1% while the rest of the markets suffered an average loss of -2.1%.

Source: Grayscale Investments

Other research by eToro shows that two-thirds of American investors are anxious about the looming recession and are ready to move their assets to safe-haven assets including cryptocurrencies. One of the most notable findings in the study was the willingness of millennials’ to invest in crypto, namely, 40% of millennials preferred cryptocurrencies as opposed to traditional safe-haven assets. 

 Ron Paul’s Twitter investment survey. Source: Ron Paul, Twitter

Most recently, a twitter poll by former US representative Ron Paul saw Bitcoin as the preferred investment over a 10-year period. 

Another study from CryptoCompare shows that a portfolio weighted with more Bitcoin than gold would have performed better so far this year.

Perception about cryptocurrency investment varies from person to person and there is no doubt that we are witnessing a gradual shift in investor perception, one inclined more towards cryptocurrency investments. What investors must also consider is the fact that Bitcoin or cryptocurrencies are not like other traditional markets. The fact that we now collectively refer to all markets apart from cryptocurrencies as traditional markets goes to show that we are dealing with something completely new and different. The rules that apply to traditional markets may not always be applicable to cryptocurrencies and the same goes regarding how their value is perceived. 

This does not, however, change the fact that Bitcoin is one of the most volatile assets out there in the market today. Flash crashes and rampant price movements are still issues that plague the crypto space. 

Some people still do not consider Bitcoin, or other cryptocurrencies, as assets, while others  do and the same is the case when it comes to Bitcoin being referred to as a safe haven. With so much uncertainty surrounding the market at the moment, Bitcoin investing has no doubt been a good alternative for investors looking to hedge their risk and as data suggests, it has been the best performing asset by far in recent years. 

Your capital is at risk.

 

eToro is the world’s leading social trading platform. Learn more at www.etoro.com

Cryptoassets are volatile instruments which can fluctuate widely in a very short time frame and ,therefore, are not appropriate for all investors. Other than via CFDs, trading cryptoassets is unregulated and ,therefore, is not supervised by any EU regulatory framework. Your capital is at risk.

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