Is Bitcoin a safe haven?

Published on 05 Nov, 2019

Cryptocurrency, a currency of the digital era, is slowly changing the norms of conventional trading. Due to its association with the dark net, it has a somewhat dodgy reputation and is not accepted in some countries. However, the currency, which has its origin in blockchain technology, is in fact technically a secure asset. Bitcoin is the most popular cryptocurrency, emerging as a favored asset to trade in due to high returns. This article examines the aspects of Bitcoin trading and its features to see if it can be considered as the next safe haven.

Can Bitcoin be the Next Safe Haven?
Cryptocurrency is a type of digital currency rapidly becoming popular as the currency of future in certain countries. The currency derives its name from cryptography, which is used to secure and verify transactions. Cryptography also includes controlling the creation of new units of a particular cryptocurrency. Essentially, cryptocurrencies can be defined as limited entries in a database that change only when specific conditions are fulfilled.

Basics of Cryptocurrency Trading
Trading in cryptocurrency is similar to forex trading. The only difference is that instead of currencies, it entails the buying and selling of cryptocurrency.

The variable factor is the changing price difference between the US dollar and a cryptocurrency such as Bitcoin, on which bets are placed. Trading can also happen between two different cryptocurrencies, for instance, Bitcoin and Litecoin. No physical assets are bought or sold; only an order is placed.

The extreme popularity of cryptocurrency trading is due to the volatility of the market which allows traders to rake in significant profits. The cryptocurrency market is open 7 days a week, 24 hours a day, implying increased risk as well as return.

Bitcoin: The Original Cryptocurrency
Bitcoin, invented in 2008 by a person or a group of people going by the pseudonym Satoshi Nakamoto, is the first-ever decentralized cryptocurrency. The identity of Satoshi Nakamoto remains a mystery till date, adding to the lure of the currency. Although Nakamoto had published a white paper related to how cryptocurrency works in 2008, it was only in 2009 that Nakamoto mined the first-ever Bitcoin, Genesis Block.

Bitcoin is based on the Blockchain technology. Blockchain is a publicly distributed ledger that records each and every Bitcoin transaction made on a block. Once the block’s memory is full, it is sequentially added to the chain of blocks. This ledger is freely available on any computer in the Bitcoin network. It validates Bitcoin transactions, stores the Blockchain and relays transactions to other network computers. The computers in the Bitcoin network are called nodes.

Bitcoins have a negative image, perceived as the currency of hackers. Ironically, hacking or stealing Bitcoin data is virtually impossible as the database is stored on a network of computers, instead of a single server. A hacker will have to break into a majority of nodes simultaneously in order to steal or hack any kind of Bitcoin data.

An additional layer of security is provided in the form of a cap on the number of Bitcoins that can ever be created or mined. This, coupled with the fact that it is a decentralized currency, ensures that it cannot be devalued in future by any additional issuance by the central bank.

Can Bitcoin be a safe haven?
Since cryptocurrencies are decentralized, they are immune to government interference or geopolitical tensions. This quality of cryptocurrencies, along with the rising trade tensions between the US and China, has led some investors to view cryptocurrencies, especially Bitcoin, as a potential safe haven.

Safe-haven assets give investors an option to park their funds and ride out of stressful situations (rising economic and geopolitical tension), and avoid risky assets such as stocks. The trade war between the US and China has triggered a global equity downturn. Bitcoin, on the other hand, rallied to a level above US$12,000 in July 2019.

Bitcoin is neither owned by a central bank, nor any single government; therefore, it is insulated from the whims of a particular bank or a political leader. It is shielded from typical political forces that underline market turbulence. Due to this reason, it was able to attain the recent highs even as trade war fears sparked off a rather vicious equity sell-off.

Bitcoin is not subject to the same forces as normal currency, which makes it a preferred choice for people who distrust their ruling government.

Today’s Bitcoin vis-à-vis gold of 1970s
There are striking similarities between the Bitcoin of today and gold of the 1970s. The annualized return on gold, the most widely accepted safe haven asset, since 1980 is 2.3% per year, which when adjusted for inflation becomes -0.7% per year. This is precisely what safe haven assets are supposed to do.

However, if one is interested in wealth creation, history suggests that you do not need a store of value, but instead an emerging store of value – an asset that has all the characteristics of a store of value, but is yet to find widespread acceptance among investors.

Gold enjoyed majority of its returns in the modern era during the 1970s.

Gold Returns by Decade

Source: Forbes

However, it must be noted that in the mid-2000s, gold enjoyed a large run owing to easy monetary policies, coupled with the launch of the SPDR Gold Shares, the first gold bullion ETF, which facilitated access to a new wave of investors.

In the 1970s, the US abandoned the gold standard, triggering a widespread uncertainty among investors who did not know how to value the metal. They were unable to ascertain if gold, untethered from the US dollar, would succeed as a safe-haven asset or be thrown in the wilderness as a “Barbarous Relic,” as John Maynard Keynes once called it.

The result of the back and forth between investors regarding the fate of gold led to a period of significant volatility. There were years, like 1975, when gold declined 25% in value, and years, like 1979, when it rose by 120%. Gold also witnessed staggering daily volatility during the 1970s, as its price fluctuated more than 3% once in every 10 days. The same volatility is now enjoyed by Bitcoin.

Therefore, it was the risk of gold being discarded as a safe haven that led to volatility in prices and strong returns. Returns spiked in tandem with the growth in the metal’s perception as a safe-haven asset, prompting an increasing number of investors to include it in their portfolio.

The same trend is seen in Bitcoin today.

Bitcoin is Both a Safe and Volatile Instrument. Let’s Get Used to it.
Analogies help in understanding unfamiliar things or subjects. We drew analogies from gold to understand the concept of a decentralized currency. Like gold, Bitcoin is scarce, fungible, portable, divisible, does not degrade over time and value while being devoid of cash flows. Furthermore, Bitcoin, at times, has given indications of being a classic store of value. For instance, when the US accused China of manipulating currency, Bitcoin prices surged (3.9%).

Bitcoin remains a risky asset as well. Compared to other proven safe instruments, Bitcoin is relatively new and like gold of the 1970s, its long-term position in the world is still insecure. Consequently, it also shares a few characteristics with other risk assets such as venture capital investments and stocks. These two factors that shelter Bitcoin from macro threats also expose it to risk and can come into direct conflict. For instance, when the market is volatile on account of macro reasons, the daily returns for Bitcoin become difficult to predict.

It can be agreed that Bitcoin is an emerging store of value. With every passing day, the number of investors accepting Bitcoin is increasing. Financial advisors and institutional investors are increasingly warming up to the idea of buying Bitcoin. Additionally, millennials, who are in favor of owning Bitcoin, compared to gold by a 9:1 ratio, are moving closer to their prime investing years, paving the way for its increasing usage and acceptance.

The dual nature of Bitcoin at present, shielded from macro threats and exposed to risk like any other risk assets, has translated into volatile but strong returns, similar to gold of the 1970s.

Or Is It An Asymmetric Asset?
As a counter argument, Bitcoin can also be viewed as an asymmetric asset. The chart below tracks the performance of Bitcoin, S&P 500 Index and gold in August 2019.

Performance Comparison of Bitcoin, Gold and the S&P 500 Index

Source: Bloomberg

Through August 2019, the S&P 500 Index showed a classic inverse correlation with gold, an established safe-haven asset. However, Bitcoin cuts through without any correlation to either the S&P 500 Index or gold.

Essentially, the chart above represents Bitcoin as an asymmetric or zero-correlation asset. Although an asymmetric asset does not sound as fancy as safe haven, it is a better option. Bitcoin is a completely new asset class, which is expected to have its own catalysts and cycles, but will remain unaffected by the usual market forces.

Bitcoin as a safe instrument narrative gained momentum when fears of a recession flared up this year. Even large media publications such as Business Insider, Bloomberg and Forbes hailed Bitcoin as a possible safe-haven asset. However, if we base our conclusion on the chart above, the narrative has not quite worked out as expected. In August 2019, the US stock markets declined 2%, while the value of gold grew 8%. Even other safe havens such as the Japanese yen and bonds witnessed substantial inflows then. The Bitcoin, on the contrary, declined 8%, like a risky asset.

The performance of Bitcoin in August 2019 presents it as a risk-on, but asymmetric asset with zero correlation to anything else in the market; this raises questions about it being a safe instrument.

As global markets dwindled earlier this year, Bitcoin rallied, leading many in the crypto-universe to believe that it could be acting like a safe-haven asset. Forbes also saw remarkable similarity between gold of the 1970s and Bitcoin of today, which further ascertained the latter’s credentials as a potential safe-haven asset.

What undermines Bitcoin’s safe haven abilities is its record of hacks and heists. Bitcoin has had more than a couple of heists since the time it emerged in 2008, the most notable being the Mt. Gox heist. In 2013, Mt. Gox witnessed a theft of 650,000 Bitcoins by a still-unknown hacker. Another such instance was a Ponzi scheme, Bitcoin Savings and Trust, operated by Trendon Shavers, which stole close to 265,675 Bitcoins from its customers.

Bitcoin has shown neither of the two traits exclusively: being a risky asset like stock markets or a safe-haven asset like gold. If we were to examine Bitcoin’s performance in August 2019, it acted like a completely new asset class, which had zero-correlation with both, the stock markets and gold. Bitcoin was the perfect asymmetric asset in August 2019.

Ironically, it has characteristics of both safe-haven and risky asset.

Bitcoin’s adoption in still at a very nascent stage but growing. We are still a long way from the velocity issues observed when a certain item turns into a value carrying asset or money and is received/spent so frequently that its price stabilizes. Presently, Bitcoin is a speculative risk asset that may become a medium of exchange or a store of value in future. However, this would be possible only if enough people speculate on it today. It would be relatively simpler to rationalize and contextualize the outsized returns that Bitcoins have produced year-to-date and are likely to in the future, if we were to view Bitcoins as an “early-stage technology.” Consequently, there should be little doubt that Bitcoin is a risky asset.

If Bitcoins were to keep rallying whenever equity markets decline, these could act as a hedge against global markets while also being uncorrelated to other asset classes. However, it is still early to make this claim, as a small period of volatility is not the true test of a safe-haven asset.

Having said this, those who believe that Bitcoin is too volatile to be considered a safe-haven asset, or are referring to the 70% decline in 2018, seem to be missing the larger point. A safe-haven asset is not an asset that never declines in value; instead, it is expected to increase or retain its value during turmoil in the market. For example, US treasuries drop substantially in value when rates increase, but not many would argue their safe-haven status. Similarly, protecting your assets against overleveraged and corrupt governments and macro factors is also a form of safe haven.

Essentially, Bitcoins have proven to be an asymmetric asset that act as safe instruments, but also bear the characteristics of risky assets.