Bitcoin — A confused role to play in macro-economics
Disclaimer: this blog post was put together for informational purposes only based on my review and analysis. This should not be construed as a solicitation, offer, or recommendation to acquire or dispose of any investment, engage in any transaction.
By Nassim Olive, CFA — Partner at Eterna Capital
Both digital assets and traditional markets investors are confused by the role Bitcoin plays in capital markets. Some experts argue Bitcoin has the characteristics of “digital gold”, hence should be considered as a safe-haven asset, others prefer to look at it as a purely speculative risky asset. One thing is clear, its price goes up and down under different market conditions, and the magnitude of the moves makes it a very volatile investment and certainly warrants caution in every investor’s portfolio.
In this short blog, I will provide some color and explanations on why, at Eterna Capital we consider Bitcoin to be a revolutionary asset with unique specifics under its current state. This would include why in turmoil it could play both the role of safety and appreciate or sell-off with other risky assets.
The argument to add Bitcoin to your investment portfolio should not be “Bitcoin is negatively correlated with other assets”, but rather “Bitcoin provides diversification” worth exploring as it remains generally uncorrelated with other assets.
Bitcoin is a risky asset with certain safe-haven properties
The month of August started with shaky capital markets driven by increased volatility and growing recession concerns with the inversion of the yield curve in both the United States and the United Kingdom (usually considered as a precursor sign of a recession). The Fed’s decision to cut rates for the first time since the last global financial crisis took the market by surprise. The market is split as investors question the move and worries about an over-inflated market valuation grow. This was followed by Trump’s announcement to impose a further 10% tariff on an additional $300bn worth of Chinese goods. As a direct response, China decided to devalue the Yuan and push it above the psychologically critical 7.0 level. With equities plunging by almost 4% over the following three trading sessions (between 31st July and 5th August 2019), it was fair to say that we witnessed a pick-up in global uncertainty in traditional markets — Bitcoin reacted as a safe-haven and spiked by more than 20% over the same period.
The flight to quality narrative was challenged mid-August when Bitcoin and the crypto market sold-off alongside global equities. While the Yuan stabilized and Trump postponed the additional tariffs application to post-Christmas, markets could not absorb some positive news. The Italian political crisis in Europe was deepening, tensions in Hong Kong were not ceasing and a surprise result in Argentina’s primary election took the local equity market down by more than 20% and the Peso down by 15% on 12th August 2019. Global equity markets roller-coaster was in full swing — Bitcoin reacted as a risky asset and dropped by more than 10% between 12th August and 15th August 2019.
Taking a step back, the direction of Bitcoin’s price both up and down last month make perfect sense. Its market capitalization is very small relative to the rest of the global markets which makes it more volatile. August started at around $10,000, after the crypto market corrected from overbought conditions and excessive leverage that had built up since May 2019. The current price is slightly above $10,000 at the time of writing this blog.
Bitcoin remains uncorrelated with global markets but it could be changing
Bitcoin’s correlation with other asset classes is a frequently discussed topic. Crypto enthusiasts have positioned Bitcoin as an asset that is uncorrelated against other assets, making it one of the best tools to provide portfolio diversification.
Historical numbers show that Bitcoin is indeed generally “uncorrelated” with global markets.
While it is important to outline that the correlation may not be statistically significant, a report published by Digital Asset Data illustrates that since mid-May 2019, Bitcoin has moved in line with gold and inversely with the S&P 500[1].
Digital Asset Data findings provide some evidence of a Bitcoin “starting to behave more like a store of value” as concluded Ryan Alfted, president of Digital Assets Data. While its market dynamics are evolving I believe that the diversification feature of Bitcoin and the long-term lack of correlation with other asset classes are more important than any short-term interpretation fueling the “safe-haven” narrative at this stage.
Bitcoin has a role to play in an investor’s portfolio
Bitcoin has a role to play out in an investor’s portfolio, it might be a potential macro hedge in economic stress conditions or another risky asset. But it remains premature to consider Bitcoin as a practical instrument for global investors to use in their asset allocation.
It is undeniable that significant progress has been made to build the infrastructure around digital assets… but we are not there yet. While we are seeing an increased number of institutional investors looking at this new asset class (according to a recent Fidelity survey [2], 47% of institutions believe digital assets have a place in their investment portfolios), it is not as practical for such institutions to take active positions in real-time. While some institutional investors are using Bitcoin futures to have exposure into this nascent market, it generally is not easy to have access to digital assets. No prime brokerage solutions are available yet, no ETF product is easily tradable and most banks prevent simple transfer of assets between digital assets and traditional assets.
Connecting the digital assets world with traditional markets is underway with the development of institutional-like products such as Bakkt (an ICE company that recently received final approval from the CFTC and NYDFS to trade physically settled Bitcoin Futures and is planning to launch late September 2019) and ErisX (a TD Ameritrade backed project that plans to offer traders access to crypto spot contracts, as well as futures contracts). We expect this sooner rather than later and when it happens, I see Bitcoin becoming a quality investment.
Conclusion
Bitcoin is widely perceived as an unconventional financial instrument but ongoing experimentation with blockchain technology, by global corporations has gathered Bitcoin greater attention and legitimacy globally.
The political and financial woes that have been fueling an economic recession are growing. It creates an opportunity for us to question the status quo. One question remains. How big of a role could Bitcoin play in this shake-up?
References
[1] Source: https://www.digitalassetsdata.com/ August 2019
[2] Source: https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/press-release/institutional-investments-in-digital-assets-050219.pdf / May 2019 / sample size of 400 institutions.
