Bitcoin falls during COVID madness, what gives?
Isn't Bitcoin supposed to hedge against this type of thing?
The markets have gone into turmoil in the last few weeks, with the S&P dropping >25%. The obvious catalyst for this drop is the black swan that is COVID-19.
With equities in freefall, how are our uncorrelated assets doing? Answer: poorly.
Gold: -12%, Bitcoin: -47%
I believe there are two explanations for this:
Bitcoin is still a risk-on asset
Bitcoin hedges inflationary shocks (theoretically), not deflationary ones
Bitcoin is still risk-on
Bitcoin is aiming to become a censorship-resistant, non-sovereign, “store of value”; a financial medium that can not be inflated away. This can’t happen overnight, we can expect the journey to last several decades. It is also not a foregone conclusion that bitcoin will even attain this status, hence the “risk” part.
I read something a few weeks ago that I think hammers home this point: Bitcoin is like an asteroid mining startup. A very stable and well-understood business (we have been mining for thousands of years), but clouded by massive uncertainty in how it will actually work. This is Bitcoin.
Bitcoin, therefore, needs to reach a critical mass before it can actually become a flight to safety assets. Until then, it is a bet that this will actually occur.
For this reason, Bitcoin is very much a risky investment, and when everything drops at once, investment funds need to ensure their portfolio meets their internal risk requirements. This means selling riskier assets to meet their cash requirements.
To summarize, bitcoin’s current state (risky asset) is being confused with its projected future state (store of value), and we need to remember not to put the cart before the horse.
Deflationary Hedge
This tweet sums up this point nicely.
Let me parse this out. Put simply, an inflationary shock is when prices increase, reducing purchasing power, largely being caused by increases to the money supply. These shocks can be the result of monetary mismanagement, or government spending exceeding the production capacity of the economy for reasons such as war. Bitcoin’s future state (store of value) protects against this.
A deflationary shock on the other hand is when the opposite happens, and prices decrease. Usually due to some exogenous factor, demand for goods and services drops, making prices drop, leading to lower employment and wages, further lowering demand. This self reinforcing cycle is called a deflationary spiral.
A pandemic is the definition of a deflationary shock, and can theoretically result in the spiral shown above. Bitcoin's future state (store of value) does NOT protect against this. I believe this can be confirmed by looking at gold, which is also down a decent amount in the last month.
However, the government will be stepping in to try and ensure that this cycle does not happen. Examples of this are yet another fed rate cut occurring on Sunday 3/15, or Mitt Romney’s suggestion to give every American $1K. The Fed will continue to try and keep the economy afloat through QE — acting as the liquidity provider of last resort. This is an inflationary shock.
We now have an inflationary response to a once-in-a-lifetime deflationary event, and it’s anyone’s guess what happens next.
However, this could be the non-sovereign Bitcoin’s time to shine as we enter this brave new world.
Disclaimer: The views expressed in this article are solely opinions of the author and do not represent financial or legal advice whether to buy, sell or hold shares of a particular cryptocurrency, cryptographic asset, stock or other investment vehicle. Prior to trading, investing or purchasing any assets, individuals should consult with their own tax, financial or legal advisor. Past performance is no guarantee of future price appreciation.