Since last October there has been a growing debate as to whether bitcoin (and other cryptocurrencies by association) are safe havens or risky, speculative assets. The stress test of the coronavirus crisis has helped to clarify this.
During the past two months, bitcoin has moved in sync with the S&P 500, betraying the fact that it is a risky asset. Gold, typically seen as a safe haven, has also risen but that is likely a response to falling interest rates, huge liquidity injections from the Fed and other central banks, and the possibility of monetary debasement.
Fed liquidity boosts bitcoin futures trading
The recovery in bitcoin has come alongside the overly generous provision of liquidity by the Fed, and the worrying development is the explosion in open interest in bitcoin futures (up to three times the average of the last year).
This points to the risk that bitcoin has now become a speculative plaything (several large hedge funds have become active in the bitcoin market) in markets and is at risk of a correction should risk appetite change.
Underlying this, on longer horizon view, bitcoin has also tended to move in sync with equities, for instance the peak in bitcoin in December 2017 prefigured weakness in equities.
Still within the less ‘independent’ crypto currency community there is a view abroad that bitcoin and crypto currencies are a ‘safe haven’ in the same way people might for instance, regard gold. Recent behavior suggests this is not the case.
From the point of view of cryptocurrencies as assets, very basic data analysis suggests that optically bitcoin has a low correlation with safe havens like gold. This does not mean that bitcoin is a good diversifier or a safe haven. It has been highly volatile over the past two years and is subject to trading and liquidity risks not normally associated with safe havens.
A further clue as to the true nature of cryptocurrencies as investable assets comes from the community of people who hold and trade them. The micro-structure (or plumbing) of markets, as well as the anthropology and sociology of those who populate them (which will have to be the subject of a future missive) is crucial to the way they behave and subsequently to their risk characteristics. Note that the current spike in bitcoin futures trading coincides with a huge spike in Robinhood account trading and in retail buying of call options.
Bitcoin futures activity explodes
Though admittedly not scientific, nor thorough, I suspect that many bitcoin traders also trade equity futures and currencies and use the same equity trading rules (technical) to buy and sell bitcoin (cryptos now have their own rating system, FCAS). If this generalization holds, it suggests that risk budgeting may drive a positive correlation between cryptocurrencies and equities, especially at market highs and lows.
Another observation is that for its size (the top ten cryptocurrencies barely add up to the market cap of JPMorgan JPM ) the crypto market attracts an inordinately large amount of attention, which may draw money in at high points. To my mind this points to bitcoin having a pro-cyclical bias in terms of its riskiness as a trading asset.
On a structural basis the coronavirus crisis may create greater interest in cryptocurrencies – especially given how the crisis have underlined the role of the digital economy and how higher taxes will be required to pay for the stimulus programs enacted.
However, the disarray surrounding Facebook’s Libra project is a sign of the operating and regulatory complexities facing cryptocurrencies. More powerful still is the incentive that central banks and fiscal authorities around the world have for the bitcoin not to succeed. Witness as an example the vigour with which the Chinese – who tightly control money flows – have clamped down on cryptocurrency exchanges.
Madness of crowds
The next steps in the crypto or digital currency (they are almost the same in that crypto currencies are digital currencies that use cryptography) industry for central banks to issue their own coins, and for the digital payments industry. More thorough regulation, cleaner cross-border payment processes and more reliable identification mechanisms will be part of the workload of central banks and governments.
In the short-run, keep an eye on the growing number of speculators in the bitcoin market – financial history shows that when new assets attract crowds, it invariably ends badly.
I am the author of a book called The Levelling which points to what’s next after globalization and puts forward constructive ideas as to how an increasingly fractured world can develop in a positive and constructive way. The book mixes economics, history, politics, finance and geopolitics. Markets are the best place to watch and test the way the world evolves. Most of my career has been spent in investment management, the last 12 years at Credit Suisse where I was the chief investment officer in the International Wealth Management Division. I started my career as an academic, at Oxford and Princeton.