While we are by no means back to ‘normalcy’ and the timetable is still murky as to when we resume business as usual, enough time has passed to hold a mirror up to how bitcoin responded to the initial Coronavirus shock and most pronounced market turmoil.
Firstly, any crisis – whether induced by biological, geopolitical or financial shocks – always results in a crisis of liquidity. Period. Peter sells some stock to pay for a loss on crypto or vice versa. Paul sells high yield bonds to buffer up MBS positions. Or simply selling winners and going to cash and short-term treasury instruments.
The vicious cycle spins and the same horror movie plays, as over-levered investors (mainly denominated in USD) need to sell indiscriminately and across asset classes. The rush to liquidity and the comfort of cash drives all correlations to one, despite promises and proselytization that some instruments are immune to this inevitable selling tsunami.
Therefore, in the most recent installment, when the VIX went to 80, and global uncertainty and fear on steroids reigned supreme, those over-levered pools of capital got flushed out again and red sprayed across our trading screens; regardless of the fundamental constructs and theses underpinning any asset classes or individual names. So, to hammer home the point once again, in any risk off environment there is no safe haven, especially not one traded as thinly and with as much speculation as bitcoin.
Holding the x-ray up to the light
Let’s take an objective look at the state of bitcoin, how it fared during peak crisis, and its role in a portfolio anchored by a long-term view and mandate.
Firstly, bitcoin is not a deep market at all and with a market cap of around $120 billion equates to that of Tesla (TSLA). It is also driven, currently, in the short term, more by over-levered speculators than by long-term holders, hence its volatility, which (while gravely exacerbated with the crisis), had vacillated with large peak to trough moves of 10,000 to 3,500 (on some exchanges) in 2020 alone [and before Coronavirus was even a driving factor]. In contrast to a safe-haven cushion that would zig while the markets zagged, bitcoin dropped over 50% while the S&P dropped 30%.
While many speculators have indeed been flushed out by employing reckless amounts of leverage, savvy trading outfits and long-term investors continue to hold. They do so for the same fundamental reasons as to why they built exposure in the first place, a thesis that has been starkly reinforced through unprecedented Central Bank action worldwide, including the US Fed’s QE to infinity stance.
So, for the true believers in bitcoin, not only have the fundamentals not changed, but they have become more pronounced and engraved into the investment psyche. Moreover, in contrast to erratic and impossible to predict monetary policies, there are more knowns within bitcoin protocols, and an inability to put the printing presses on autopilot. On the contrary, a halvening in mid-May will result in less availability and scarcity as the block reward will fall from 12.5BTC per block to 6.25 (a block is roughly mined every 10 minutes), so a greater worth is placed on each unit, or coin – similar to less mining equating to higher demand for existing reserves of gold, also touted as an asset to hold in unhinged times.
Bitcoin versus Gold
Now that we have morphed from an initial liquidity crisis into the potential next phase of a crisis (usually credit crisis, but could take on others forms), we can talk more rationally about safe haven assets and their long-term role in providing diversification and a non-correlating return stream to traditional equity and bond portfolios.
Many talking heads myopically preach either gold or bitcoin as the sole answer in dire times, often taking to public forums to attack each other and create a schism between either camp. As noted, neither acts as promised (at least initially), and there is no need to play a zero-sum game here. One could argue the merits of holding both as diversification tools and alternate stores of value, each with their own idiosyncratic benefits and use cases.
While gold certainly has a deep history narrating its utility and potential worth, bitcoin has more attractive, contemporary features, such as no physical delivery, no storage, and greater immutability and real-life payment applications. All valid reasons why many have made its case as a replacement to gold.
My view is that institutional allocators and stewards of capital should have exposure to both, placing at least 50% of their current gold holdings (usually 1-2% of an overall portfolio) into bitcoin. Those taking a 10-year outlook will see the non-correlation benefits to their portfolios and their participation (alongside the continued weeding out of weak players) will also smooth out volatility as larger tickets and block trades counterbalance shorter-term trading strategies.
While perhaps more evident to a newer generation embracing a more futuristic mind-set, bitcoin also provides exposure to an underlying network effect the value of which is not currently priced in, built on the premise of more decentralization, the utility and staying power of blockchain technologies and emerging tokens of value (stablecoins, security tokens etc.) that will coalesce to eventually make the asset truly reflect and catch up to the sum of its parts.
What does not kill you makes your stronger
While the current crisis engulfing our daily lives and the global economy is eerily unique, many of the lessons learned ring true from prior market disruptions and dislocations:
- The lottery mentality still exists for some and too much leverage always blows up the casino
- While all asset classes will be volatile to the downside short-term, they will revert to the mean longer-term
Sophisticated traders and long-term institutional investors alike should be easing their way in and taking a nibble at this digital diversifier, especially against the macro backdrop of irreversible currency debasement.
Moreover, structural positives did arise from this latest stress test, with the crypto infrastructure holding up and proving its mettle across custody, trading and execution — which all came together to function in a global 24/7 environment that is very different from traditional market machinations.
The ecosystem is evolving and getting stronger and with that we need to advance the mindset, rationale for investing, and pools of incoming capital to strengthen the asset class.
The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine, Markets Media Group or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community.