HomeServicesCompanyInsightsCareersContactE-Banking
IntroductionGold's behaviour in past crisesCOVID-19 crisisAnalysis of previous bitcoin bottomsConclusion
Friday, 3 April, 2020
The Digital Investor

Bitcoin, gold, and coronavirus

Abstract

This article fulfills two objectives. First, it analyses the historical performance of gold amidst major crises and draws parallels with bitcoin’s response to the current situation. Second, it spots similarities between current and historical fundamentals when bitcoin had found a local bottom.

Introduction

While the second largest economy in the world was busy fighting the coronavirus, the US stock market was making new all-time highs, utterly unconcerned about the havoc wreaked by the virus in the other part of the world. Soon, the virus made inroads into the West and markets began to tumble. The fall was steep, as if markets had hit a wall. Everything fell as if there was no future.

To eradicate the virus, governments have taken drastic measures that are essentially leading to the shutting down of the world economy, as The Economist shockingly illustrated in its 19 March edition: Planet earth is shutting downPlanet earth is shutting downlink1.

The Coronavirus has caused unprecedented economic and financial shocks. Never in human history has a shock been so swift, violent and global. The shock has been so severe that it has dragged all assets in its wake, including supposedly safe assets such as gold and bitcoin.

To get an initial grasp of the magnitude of the shock, one needs to realise that one week of activity is equivalent to 1.9% of GDP (100%/52 weeks). In other words, based on this crude metric, one week of shutdown is equivalent to a GDP loss of 1.9%. And to give some context, advanced economies grew by 1.7% last year according to the IMFIMFlink1.

The cumulative cost of an extra week grows exponentially as the very survival of many companies is seriously impaired. Chinese industrial production fell by 13.5% in the first two months of the year.

To lessen the economic and financial costs, governments have launched huge fiscal stimuli. In the US for instance, President Trump signed a USD 2 trillion stimulus, about 10% of GDP. It is the largest stimulus of modern history – or put differently, it is at best just five weeks of GDP!

In this issue, we analyse the coronavirus asset price action in the light of a selection of historical sell-offs to gain an insight into bitcoin’s behaviour. We also portray how some of the current bitcoin fundamentals resemble conditions pertaining to previous bitcoin bottoms.

What has happened in the markets?

In the recent crash, the independence of bitcoin relative to other assets has been challenged as it dropped by more than the S&P500 index. Many are tempted to conclude by saying the diversification argument does not hold anymore. We have a different opinion, and this article is about why we think bitcoin remains attractive in the portfolio context.

Despite the uniqueness of the current situation, history offers parallels that help us better understand financial market behaviours in periods of acute stress and what we can expect once the shock is absorbed.

Gold's behaviour in past crises

We analyse three examples of financial stress with a focus on gold, an asset revered as a classic diversifier and one that is close in spirit to the notion of outside money, of which bitcoin is part. We presented this in the previous Digital Investor: Bitcoin is dead, long live bitcoin Bitcoin is dead, long live bitcoinlink1.

Black Monday, Oct 1987

Figure 1: Black Monday (gold remained a hedge throughout)

Source: SEBA Research

In this case, during the initial phase gold rallied as equities fell, and when equities started recovering, gold fell again. Gold worked as a hedge around the Black Monday crisis.

Dot-com bubble burst, 2000-2002

Figure 2: Dot-com bubble (gold moved in lockstep with equities before breaking away)

Source: SEBA Research, Tradingview

During the dot-com bubble burst, though gold behaved as a hedge at the beginning, it also had periods of extremely high correlation with equities.

Global financial crisis, 2007-2008

Figure 3: Global financial crisis (gold followed the same directional pattern as equities)

Source: SEBA Research, Tradingview

Gold performed differently in the three crises. Gold’s correlation with S&P saw sharp spikes during crisis periods, however, over the longer term, there are no doubts regarding gold’s position as a diversifier. Over the past 30 years, the correlation1 between gold and S&P500 averages -0.05.

Figure 4: Rolling correlations of S&P vs gold

Source: SEBA Research, Tradingview

COVID-19 crisis

Bitcoin was born after the global financial crisis (GFC) and is now experiencing its first global crisis. When the crisis hit, we observed a typical flight to liquidity as investors sold everything they could. Crypto-investors seem to have acted accordingly. This articleThis articlelink1 shows that the sell-off was driven by short-term holders, which could mean that it was driven by leveraged retail investors or institutions. As we can see in figure 5, the 1 month and 12 month rolling correlations between bitcoin and SPX shot above 0.65 and 0.25 respectively, the first time in both cases.

Figure 5: Rolling correlations of BTC vs S&P

Source: SEBA Research, Coinmetrics, Tradingview

We think that one of the major reasons for the correlation spike is the rate at which markets fell. To put this in context, we looked at historical crises. As shown in figure 6, the rate at which markets have fallen during the current crisis is unprecedented. S&P registered the top on 19 February and it fell by 30% in 19 working days versus 40 days for Black Monday, and almost a year for the GFC. The rapid fall illustrates how surprised markets were and the reading of this chart underscores the sense of panic that lead investors to sell what they could, resulting in high correlations among asset classes.

Figure 6: Comparison of S&P 500 performance during major crises

Source: SEBA Research, Tradingview

We think that cryptocurrencies fell more than other broader markets because of multiple factors. Governments intervene in traditional markets by employing various methods such as circuit breakers, rate cuts, repo facilities, commercial papers, bailouts, helicopter money and so on. Cryptocurrencies have none of these.

The aforementioned measures reduce the pain in the short term. In our view, they affect the price discovery mechanism and do not let the free markets do their job. The actual problem is only masked and the inevitable is just delayed, not avoided.

Figure 7: Performance of different assets during the COVID-19 crisis

Source: SEBA Research, Tradingview

Our analysis shows that this phase of high correlation could be an exception over the long-term trend. Just like gold, bitcoin is also a form of outside money, a type of asset that is the liability of nobody and cannot be manipulated by anyone.

After the recent sell-off, the correlation has shrunk. This behaviour is similar to what we have observed with gold and S&P 500 during the dot-com bubble burst. Therefore, dismissing that bitcoin offers diversification based on short bursts of high correlation is not a good strategy in our view.

Analysis of previous bitcoin bottoms

Now, if the correlation is shrinking, does it mean bitcoin has bottomed at around USD 3,800? We can only make an educated guess whether the bottom is already in. We look at the history of bitcoin bottoms and try to draw parallels from fundamental perspectives.

One of the best things about bitcoin is arguably its difficulty adjustment algorithm2, which is a self-stabilising mechanism. The difficulty is adjusted about every two weeks. If more miners are plugged in, i.e. the hashrate is increasing, the difficulty increases and vice-versa.

Downward difficulty adjustments of higher magnitudes have historically marked local bottoms for bitcoin. On 26 March, the difficulty adjusted downwards by 16%, making this the second-largest drop in history. Reduced difficulty demands less energy, thereby reducing the cost of mining bitcoin and increasing miners’ profitability. As a result, more miners join, and the hashrate climbs again.

Typically, the hashrate drops after sudden drops in prices as marginal miners start running losses. This is what happened after the recent price crash as well. The hashrate, a measure of mining activity, dropped to about 75 million TH/s from about 100 million TH/s. After the difficulty was adjusted, the hashrate jumped back to 111 million TH/s, signalling strong support by the miners.

Figure 8: Bitcoin bottoms (difficulty adjustment vs price)

Source: SEBA Research, Coinmetrics

Stablecoin market cap shows that space is far from dead

The market capitalisation of stablecoins has been increasing steadily. In 2020 stablecoins saw a steady rise of 20%, and during the recent sell-off, the demand for stablecoins has remained solid. Stablecoins offer easy convertibility into other cryptocurrencies compared to fiat on-ramps.

Stablecoins are built on top of existing blockchains. The growing demand for stablecoins gives us confidence that space is, in fact, thriving.

Figure 9: Stablecoin market cap shows steady growth

Source: SEBA Research, Coinmarketcap

Conclusion

Observations of gold’s performance as outside money in the past few crises suggests that measuring correlation or diversification over a short period is not wise. Bitcoin’s design allows it to continue operating in phases where the price drops drastically.

The outside money characteristics of bitcoin coupled with bitcoin’s ability to continue to operate in phases where the price remains low, and unaffected demand for stablecoins even after the recent crash suggest that the long-term future of the field is intact.

Does this mean that we know for certain that bitcoin is going to bounce regardless of what happens to other asset classes? Absolutely not. Only it is premature to conclude that diversification does not work. Bitcoin had been pronounced dead 380 timespronounced dead 380 timeslink1 before the recent crash by prominent personalities. This will be bitcoin’s 381st death, and it will be resurrected for the 381st time.


11 month rolling correlation
2For every 2,016 blocks, bitcoin adjusts the difficulty at which blocks can be mined. If 2,016 blocks are mined sooner than the anticipated time of two weeks, the difficulty is adjusted higher and vice-versa. For more details, please refer to Mining: The essence of proof of work (https://www.seba.swiss/research/Mining-the-essence-of-proof-of-work/)
Download pdf
Share:
Subscribe to the research newsletter and get weekly updates about the latest articles of SEBAresearch
Subscribe to newsletter

Authors


Yves Longchamp
Head of Research
SEBA Bank AG
in
Saurabh Deshpande
Research Analyst
B&B Analytics Private Limited
in
Ujjwal Mehra
Research Analyst
B&B Analytics Private Limited
in
research@seba.swiss | Disclaimer

Disclaimer

This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is published solely for information purposes; it is not an advertisement nor is it a solicitation or an offer to buy or sell any financial investment or to participate in any particular investment strategy. This document is for distribution only under such circumstances as may be permitted by applicable law. It is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction.

No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained in this document, except with respect to information concerning SEBA. The information is not intended to be a complete statement or summary of the financial investments, markets or developments referred to in the document. SEBA does not undertake to update or keep current the information. Any statements contained in this document attributed to a third party represent SEBA's interpretation of the data, information and/or opinions provided by that third party either publicly or through a subscription service, and such use and interpretation have not been reviewed by the third party.

Any prices stated in this document are for information purposes only and do not represent valuations for individual investments. There is no representation that any transaction can or could have been effected at those prices, and any prices do not necessarily reflect SEBA’s internal books and records or theoretical model-based valuations and may be based on certain assumptions. Different assumptions by SEBA or any other source may yield substantially different results.

Nothing in this document constitutes a representation that any investment strategy or investment is suitable or appropriate to an investor’s individual circumstances or otherwise constitutes a personal recommendation. Investments involve risks, and investors should exercise prudence and their own judgment in making their investment decisions. Financial investments described in the document may not be eligible for sale in all jurisdictions or to certain categories of investors. Certain services and products are subject to legal restrictions and cannot be offered on an unrestricted basis to certain investors. Recipients are therefore asked to consult the restrictions relating to investments, products or services for further information. Furthermore, recipients may consult their legal/tax advisors should they require any clarifications. SEBA and any of its directors or employees may be entitled at any time to hold long or short positions in investments, carry out transactions involving relevant investments in the capacity of principal or agent, or provide any other services or have officers, who serve as directors, either to/for the issuer, the investment itself or to/for any company commercially or financially affiliated to such investment.

At any time, investment decisions (including whether to buy, sell or hold investments) made by SEBA and its employees may differ from or be contrary to the opinions expressed in SEBA research publications.

Some investments may not be readily realizable since the market is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. Investing in digital assets including cryptocurrencies as well as in futures and options is not suitable for every investor as there is a substantial risk of loss, and losses in excess of an initial investment may under certain circumstances occur. The value of any investment or income may go down as well as up, and investors may not get back the full amount invested. Past performance of an investment is no guarantee for its future performance. Additional information will be made available upon request. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. Tax treatment depends on the individual circumstances and may be subject to change in the future.

SEBA does not provide legal or tax advice and makes no representations as to the tax treatment of assets or the investment returns thereon both in general or with reference to specific investor’s circumstances and needs. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of individual investors and we would recommend that you take financial and/or tax advice as to the implications (including tax) prior to investing. Neither SEBA nor any of its directors, employees or agents accepts any liability for any loss (including investment loss) or damage arising out of the use of all or any of the Information provided in the document.

This document may not be reproduced or copies circulated without prior authority of SEBA. Unless otherwise agreed in writing SEBA expressly prohibits the distribution and transfer of this document to third parties for any reason. SEBA accepts no liability whatsoever for any claims or lawsuits from any third parties arising from the use or distribution of this document.

Research will initiate, update and cease coverage solely at the discretion of SEBA. The information contained in this document is based on numerous assumptions. Different assumptions could result in materially different results. SEBA may use research input provided by analysts employed by its affiliate B&B Analytics Private Limited, Mumbai. The analyst(s) responsible for the preparation of this document may interact with trading desk personnel, sales personnel and other parties for the purpose of gathering, applying and interpreting market information The compensation of the analyst who prepared this document is determined exclusively by SEBA.

Austria: SEBA is not licensed to conduct banking and financial activities in Austria nor is SEBA supervised by the Austrian Financial Market Authority (Finanzmarktaufsicht), to which this document has not been submitted for approval. France: SEBA is not licensed to conduct banking and financial activities in France nor is SEBA supervised by French banking and financial authorities. Italy: SEBA is not licensed to conduct banking and financial activities in Italy nor is SEBA supervised by the Bank of Italy (Banca d’Italia) and the Italian Financial Markets Supervisory Authority (CONSOB - Commissione Nazionale per le Società e la Borsa), to which this document has not been submitted for approval. Germany: SEBA is not licensed to conduct banking and financial activities in Germany nor is SEBA supervised by the German Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht), to which this document has not been submitted for approval. Hong-Kong: SEBA is not licensed to conduct banking and financial activities in Hong-Kong nor is SEBA supervised by banking and financial authorities in Hong-Kong, to which this document has not been submitted for approval. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Hong-Kong where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not “professional investors” within the meaning of the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) and any rules made thereunder (the “SFO”). Netherlands: This publication has been produced by SEBA, which is not authorised to provide regulated services in the Netherlands. Portugal: SEBA is not licensed to conduct banking and financial activities in Portugal nor is SEBA supervised by the Portuguese regulators Bank of Portugal “Banco de Portugal” and Portuguese Securities Exchange Commission “Comissao do Mercado de Valores Mobiliarios”. Singapore: SEBA is not licensed to conduct banking and financial activities in SIngapore nor is SEBA supervised by banking and financial authorities in Singapore, to which this document has not been submitted for approval. This document was provided to you as a result of a request received by SEBA from you and/or persons entitled to make the request on your behalf. Should you have received the document erroneously, SEBA asks that you kindly destroy/delete it and inform SEBA immediately. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Singapore where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not accredited investors, expert investors or institutional investors as defined in section 4A of the Securities and Futures Act (Cap. 289 of Singapore) (“SFA”). UK: This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product.

SEBA is not an authorised person for purposes of the Financial Services and Markets Act (FSMA), and accordingly, any information if deemed a financial promotion is provided only to persons in the UK reasonably believed to be of a kind to whom promotions may be communicated by an unauthorised person pursuant to an exemption under the FSMA (Financial Promotion) Order 2005 (the “FPO”). Such persons include: (a) persons having professional experience in matters relating to investments (“Investment Professionals”) and (b) high net worth bodies corporate, partnerships, unincorporated associations, trusts, etc. falling within Article 49 of the FPO (“High Net Worth Businesses”). High Net Worth Businesses include: (i) a corporation which has called-up share capital or net assets of at least £5 million or is a member of a group in which includes a company with called-up share capital or net assets of at least £5 million (but where the corporation has more than 20 shareholders or it is a subsidiary of a company with more than 20 shareholders, the £5 million share capital / net assets requirement is reduced to £500,000); (ii) a partnership or unincorporated association with net assets of at least £5 million and (iii) a trustee of a trust which has had gross assets (i.e. total assets held before deduction of any liabilities) of at least £10 million at any time within the year preceding the promotion. Any financial promotion information is available only to such persons, and persons of any other description in the UK may not rely on the information in it. Most of the protections provided by the UK regulatory system, and compensation under the UK Financial Services Compensation Scheme, will not be available.

© SEBA / Grafenauweg 6, 6300 Zug, Switzerland

Research

more
Research report
COVID-19 pandemic places digital payment regulation at centre stage
14 May, 2020
COVID-19 has renewed the regulatory focus on digital payments, reminding us that digital payment solutions require regulatory certainty.
Read more
Research report
Bitcoin halving: The battle of hard and soft money
07 May, 2020
Bitcoin halving is just around the corner. In this Digital Investor edition, the first section compares and contrasts halvings of Bitcoin and other assets. The second section invites readers to explore how mining dynamics are expected to change post-halving. We then estimate how prices may behave given a no-arbitrage condition.
Read more
Research report
How Crypto-Asset Wallets Work
23 April, 2020
In this edition of The Bridge, we introduce you to different types of encryption techniques and how crypto-asset wallet encryption techniques secure transactions in a blockchain network.
Read more

Join us as we redefine finance.

Contact us
seba

SEBA Bank AG
Kolinplatz 15
6300 Zug
Switzerland

ServicesCompanyNews & InsightsCareersContact
Receive the newest insights, research and news from SEBA directly to your inbox
Newsletter subscription
© 2020 SEBA Bank AG