What happened this month in the financial markets?The eoconomic and financial consequences of the battle against the coronavirusOutside moneyWhat does the coronavirus crisis tell us about cryptocurrencies?Conclusion
Sunday, 22 March, 2020
The Digital Investor
Bitcoin is dead, long live Bitcoin
What happened this month in the financial markets?
At the time the coronavirus started to expand in the rest of Europe from northern Italy, financial markets tumbled. Crypto-currencies were among the most heavily affected assets. The bitcoin price halved. On March 12, 2020, it declined by more than 40 percent! Even considering the tumultuous reputation of Bitcoin, such a drop is massive and unusual. This dramatic decline has been fuelled by the liquidation of highly leveraged positions in a small market dominated by retail investors.
Was there any place to hide? Looking at traditional markets, the drop in prices has also been massive and unusual. The S&P500 and the Dow Jones indices lost more than 30 percent from their peak in about a month's time. After Black Monday on October 19, 1987, the Dow Jones recorded the second largest daily drop in its entire history1.
When comparing the 30 percent decline in equities with the more than 50 percent decline in Bitcoin, it is important to remember that traditional assets were supported by massive injections of liquidity, increase in the quantitative easing programme, lowering of interest rates, and stock market circuit breakers, to name a few. Such instruments do not exist for cryptocurrencies. What would have happened if they had not been used for traditional assets?
When such a price action takes place, all asset classes are hit badly, independent of their characteristics. The downside correlation increases. These movements are similar to those observed in the wake of the Lehman moment in 2008.
Even safe assets such as gold did not perform well, a situation that was also observed in 2008 during the global financial crisis (GFC). It illustrates that when a major shock hits the financial markets, investors look for liquidity rather than quality. This is the reason why US Treasuries performed well during these periods of acute stress. In just a few days, the yield for the ten-year Treasury declined by roughly 100 basis points to a historical low of 0.6 percent.
Despite the exponential increase in the number of people affected by the coronavirus, financial markets have started to somehow de-correlate: the US Treasury benchmark yield rose to over 1 percent, while stocks continued to decline and Bitcoin rose to about USD 6800.
If such a troubled period were to recur, in which currency would an investor keep their savings safe? Outside money is the answer. It is a form of money that is not liable to anyone within the economic system. Throughout history, precious metals such as gold and silver have played the role of outside money, as they have been accepted internationally as a means of payments.
It’s important to note that outside money is the currency of choice used to settle a transaction where there is no trust between the two parties. This was the case thousands of years ago in long distance trading, when merchants from different countries exchanged goods for gold. This is still the case today during wars, when countries pay for imports in gold as their national currency is not accepted across the border.
Cryptocurrencies such as Bitcoin, Litecoin etc. are a new form of outside money, as they have many similarities with gold and silver. They can be used in a situation where there is no trust, they are not liable to anyone and cannot be manipulated because their supply is fixed. The supply is a part of the social construct and cannot be changed unless the majority of the community agrees. For example, although Bitcoin’s cap of 21 million can be technically changed, it will not be changed as the social construct will most certainly never allow it to be changed.
They also have an additional advantage over the traditional form of outside money: they are easy to transport and store. Finally, they are very practical, as you can use them to buy a coffee. When did you last buy your coffee with a gold or a silver coin?
The coronavirus has impacted our life in ways that were unimaginable a month ago! Governments have taken harsh measures to limit the spread of the virus. As a consequence, economic acitivity has been severaly affected and asset prices have dropped massively. As for crypto assets, Bitcoin has been hit even harder.
There is no doubt that we will win the battle against the coronavirus. However, this battle will come at a cost. Public debt and central bank balance sheets will continue to increase, limiting their room of action going forward. The international monetary system may well come under pressure if confidence in these institutions wanes.
Outside money is an asset class that protects against this type of risk. Some cryptocurrencies such as Bitcoin are new forms of outside money. We are therefore confident that the value proposition of cryptocurrencies will remain intact.
Finally, native cryptocurrencies represent an integral part of the blockchain technology, which supports a wide variety of applications. One application is outside money, and Bitcoin, designed as digital gold, proposes this feature. The number of applications that this technology supports is enormous. Crypto-currencies are about more than just outside money.
The value contribution of cryptocurrencies is very topical, and we believe Bitcoin remains an attractive diversifier for portfolios.
1The Dow Jones Industrial Average exists since 16 Febuary 1885! ↵
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