Bitcoin is often thought of as the perfect hedge asset. The story worth mentioning here is that, in the end, the fact that the global central bank always plays the role of creating a huge amount of money will come to a glorious end and cryptocurrencies will finally have an end. like that. Of course, the precious metal is often thought to be a “relic of barbarism” and will certainly not compete with this “new world currency” hypothesis.
I have a lot of doubts about that story, in my opinion, if US dollars suddenly become worthless, it seems like the last thing I will do is trust a vulnerable electronic network. However, I see bitcoin and cryptocurrencies as a whole as a portfolio with relatively viable returns due to its low correlation with other assets and is increasingly believed to be a “safe hedge. “.
There has been a lot of speculation about bitcoin’s macro fundamentals. As an analyst, I think it’s time to try to separate hypotheses from reality and find Bitcoin’s real role in the world economic engine.
Hypothesis: Gold and Bitcoin are in direct competition
There are two groups that fundamentally share the same macroeconomic stance but tend to be contradictory: precious metal investors and cryptocurrency investors. Both tend to hold the view that fiat money will eventually go away, but differ on whether alternative currencies should be physical or crypto. Of course, the debate tends to be relevant to ages where young people vie for digital money on the one hand and the elderly in favor of the “classic yellow metal” on the other.
The statistical fact is that gold and bitcoin often have a positive correlation and become more and more like that. Here is a chart of the correlation between rolling years between Bitcoin’s daily percentage changes and the Gold ETF (GLD):
Here we can see that in Bitcoin’s nascent early stage (which essentially stretched back to 2016, when it was widely known), it did not have a steady correlation with gold. Since then, the correlation has increased, decreased, and since November 2018, represents a trend towards a new all-time high correlation level.
Currently, the correlation index of 0.20 is still relatively low but still statistically significant. This means that: the trend of “bottom race” currency competition became more prevalent after the crisis in October of last year and the demand for alternative currencies is increasing.
On a more macro perspective, both of these alternative currencies are very versatile. Like Bitcoin, most of the world’s “gold” exists only on paper and if people ask for “delivery” that amount of money will not be enough. Both also get support from the hypothesis of a decline in fiat money and both have a fixed supply.
Overall, as financial uncertainties continue to adversely affect the market, I wouldn’t be surprised if this correlation continues to increase. There is ample evidence to support the hypothesis that Bitcoin is becoming a “defensive” asset. Take a look at the growing correlation between Bitcoin and the long-term treasury bond (TLT) below:
This double correlation is weaker than that of Gold and Bitcoin, but there is a similarity that the “risk reduction” allocation benefit is likely to increase.
Alternatively, one can reasonably conclude that lower interest rates could also support Bitcoin more. An increase in the positive correlation between Bitcoin and a treasury bond is also seen in a Treasury Inflation-protected bond (TIP) and a short-term treasury (SHY) bond. Ultimately, lower interest rates will drive the volatility of global currencies, which helps to explain the recent rise in Bitcoin, gold and government bonds.
Fact: Bitcoin is an economy’s hedge against risks
In general, cryptocurrencies are relatively unaffected by the relationship between the stock market and cryptocurrencies. On the one hand, bitcoin benefits from the same excess economic liquidity as stocks, as seen in the 2017 rally. On the other hand, Bitcoin does not quite get the effect of “economic growth” on it. the stock market and can be seen as a “safe haven”, although this asset, is not really stable.
Let’s see what we can do to resolve this debate. Below is a chart of Bitcoin’s correlation with the S&P 500 (SPY):
In general, one correlation pattern is less statistically significant than the other two but follows a more logical trend. If you’ve been following along, you may have noticed a slight change in policy earlier this year that has made it a “risk reduction” asset. An example has been noted by Bloomberg that, increased demand for Bitcoin has emerged in Argentina and Hong Kong amid financial instability in those places.
Currently, the correlation stands at -0.09 and is declining rapidly. That number will need to be at -0.15 to be able to definitively say “bitcoin and stocks are inversely correlated”, but it looks like it will happen soon.
Hypothesis: Bitcoin rises due to currency volatility
At least not yet. It is believed that when money becomes unstable, people will turn to bitcoin. The truth is, Bitcoin is being used as an asset defense in places like Venezuela and Zimbabwe. That said, currency volatility from the developed world is a statistically neutral, if not negative, for Bitcoin.
To measure this, I took an average currency volatility measurement for the euro, yen, Canadian dollar, British pound, and Singapore dollar, and measured the double correlation with Bitcoin.
The reality is that there is no clear relationship between these two currencies. In general, the double correlation measure is negative, but since “currency volatility” is not stable, we will need to see a correlation of about 0.25 for statistical significance. That said, we can say with certainty that today, currency volatility has no positive effect on Bitcoin price.
What are the trends in emerging market currencies? The problem arises about the negative relationship between the Chinese Yuan (CYB) and Bitcoin:
The measurement results have become consistently negative. Late last year and this year, it made a short jump into territory positively, then back into negative territory following China’s recent currency devaluation. This supports the hypothesis that Bitcoin may be more suitable for emerging market economies where currency manipulation is more than those in the developed world.
Like Bitcoin’s correlation with other assets, the debate over Bitcoin’s place in the global economic engine is unlikely to draw conclusive conclusions anytime soon. Overall, Bitcoin appears to be trying to hold a place among ‘defensive assets’, as it has made strong movements in these correlations this year.
The reality is that there is a global trend among investors and individuals who wish to protect their wealth from their home governments. Emerging market countries’ currency volatility is nothing new but has become more severe in recent years. Interest rates have fallen to their lowest levels and stocks have become expensive, especially in a recessionary economic state. So where should we put the money? Should we buy it all in precious metals? It is possible, but even then, as the investor wise, we should not put all of our eggs in one basket.
Overall, Bitcoin is becoming a highly viable alternative. It is not quite a substitute for gold but an addition to it. Personally, I think Bitcoin’s recent bull run will end with another sharp drop because it could still be associated with global demand for liquidity. Remember, gold fell to the market in 2008 because investors needed to make margin calls. I wouldn’t be surprised if some part of Bitcoin owners had risky investments that could force them to sell cryptocurrencies. In the long run, however, I think it’s safe to say that Bitcoin still exists and has at least one small place in our portfolio.