Cryptocurrency (“crypto”) has always been thought of as a currency that would perform extremely well during an economic crisis. However, ever since its rise to fame, it has never seen an economic crisis (despite having had numerous crises of its own). This led to its perceived performance in a crisis being little more than just a theory. However, the COVID-19 crisis has finally given us real-world data in this regard. Even extremely conservative investors who avoided crypto like the plague can now analyze and decide whether a part of their portfolio should be in cryptocurrency.
I will be taking you through the basics of cryptocurrency. After that, we will take a look at its performance in the recent crisis. Lastly, we will look at whether or not it is a viable investment in the long run.
What is Cryptocurrency?
Simply put, cryptocurrency is an internet-based currency system. It uses a decentralized ledger (called the Blockchain) to keep track of all of the transactions, and no one owns or backs the currency. A centralized ledger, such as your bank statement, has an entity keeping track of all the transactions. In a decentralized ledger, everyone keeps track of the changes together.
Anyone can own it, anyone can trade it, and it can be used for a plethora of purposes (more and more stores are offering crypto-based payments).
Being decentralized means that there is no reserve or country that owns or guarantees crypto. While Bitcoin is by far the most popular and the original cryptocurrency, there are literally thousands of coins for you to choose from.
An important point here is that crypto is different than any other type of currency. While there are no assets backing a specific coin, there is only a limited supply. More cryptocurrency is added through mining, a complex process that rewards miners with a small amount of cryptocurrency. Cryptocurrency can only be mined to an extent, after which it is impossible to generate more.
Owning cryptocurrency is quite simple. There are hundreds of reputable exchanges where you can trade-in your fiat currency for a coin of your choice. However, not all coins are the same. In fact, there is no clear proof of owning crypto being a good idea. It is, quite literally, one of the most controversial financial innovations in history.
There is no need to delve into the technical details. Instead, we will take a look at Bitcoin’s performance when the pandemic was at its peak. Other currencies are correlated to Bitcoin’s performance in one way or the other, so using Bitcoin as a benchmark is a good idea. Using its performance, and the theory behind the idea of cryptocurrency, we will see whether cryptocurrency is a good hedge during a crisis.
How Bitcoin Performed During the Pandemic
We will be using Bitcoin as the principal investment against which all of the other assets will be measured. First, we will compare Bitcoin with stocks, as they are usually considered the main investment from a long-term perspective. We will also take a look at gold, another asset that is considered safe and supposed to perform well during a crisis. Lastly, we will look at bond yields as bonds are considered the safest asset no matter what the situation.
The data we will look at will be from the beginning of February to the end of April 2020. While the full economic repercussions of the pandemic will not be obvious for at least a few more months, we began to see some form of normalization beginning in May. Businesses are starting to reopen (while keeping social distancing measures in place) and economic activity is slowly returning. As such, our analysis covers the three months during which the panic in the global economy was at full swing.
Bitcoin Against Stocks
On the surface of it, Bitcoin has performed better than stocks during the aforementioned 3 months. However, it has also been a lot more volatile. During the first few weeks of the crisis, the S&P 500 fell from 3393.86 to 2191.52 (-35.38%). Bitcoin, on the other hand, fell from 10492.56 to 3966.28 (-62.19%).
Overall, Bitcoin was down 6.82% at the end of April whereas the S&P 500 was down 15.90% adjusted for inflation. Bitcoin being more volatile is something that everybody expects. However, extremely high volatility such as seen during the pandemic does not make Bitcoin a good safe haven.
During times of crisis, your number one investment goal should be to preserve your wealth. Watching your investment tank by over 60% in a matter of weeks is definitely not the way to go about it. That said, despite all of its ups and downs, Bitcoin did eventually recover. By that metric, it is a decent store of wealth. Let’s take a look at how it compares to some of the other ‘safe’ assets.
Bitcoin Against Gold
Gold has always been considered an asset that you hold to store your wealth. Remember that over the long-term, hoarding gold is definitely not a good idea. Stocks tend to do much better over the long run. Still, gold seems to be a viable investment during a market downturn or during periods of unusually high inflation.
True to its reputation, gold was quite stable between February and April. In fact, it rose from $1577.20 to $1688.74 per ounce, an increase of 7.05%. Even its biggest dip during this time was from $1674.50 to $1477.30 (-11.78%).
It seems that gold was an extremely good investment during the pandemic as compared to Bitcoin. Not only did it stay relatively stable throughout, but it also had much better returns. Let’s take a look at government securities.
Bitcoin Against Treasury Bonds
Lastly, we will take a broad look at treasury bonds. Usually, yields of treasury bonds collapse during a crisis as people flock to purchase them. This pushes their price up, thereby decreasing their Yield To Maturity (this is basically the return you will make if you buy the bond and hold it until it matures and you are repaid). Treasury securities are meant to be a guaranteed store of wealth. They will not make you a lot of money, but they will make sure you don’t lose it either (unless you purchase them at a negative yield – at the time of writing French government bonds have negative yields!).
This is exactly what happened during the pandemic. Those who purchased bonds at the earliest made a lot of money due to the rapid increase in their price. Others still managed to purchase bonds at a price where they managed to not lose money at the very least.
While bonds seemed to do quite well compared to Bitcoin initially, Bitcoin is a much better asset when recovering. Bitcoin has reacted quicker to the stimulus measures. Still, bonds definitely seem like the smarter move when the panic is at the maximum.
Conclusion
From the brief analysis conducted above, Bitcoin does not seem to be a great asset for dealing with an economic crisis. The main reason for this seems to be its volatility. Investor confidence erodes pretty fast in cryptocurrencies, and the recent crisis is a prime example of that.
Those looking to preserve their wealth when a crisis is looming should probably stick to conventional safe havens such as gold and treasury securities. Of course, this was the first real crisis that Bitcoin went through. The result may be entirely different in the next one. Still, the current data that we have shows Bitcoin is not a great asset in a crisis.
However, how is Bitcoin as a long-term investment? Let’s take a brief look at whether or not cryptocurrency should be a part of your portfolio.
Cryptocurrency in The Long Term
There are two ways through which cryptocurrency may be worth a lot more in the future than it is now.
The first one is through its adoption as a payment method throughout the world. It doesn’t have to replace fiat currency. All it needs to do is to be recognized as a valid currency by a high percentage of the world’s retailers, companies, and stores.
Once this happens, not only will the demand for cryptocurrency increase exponentially (due to its numerous advantages over traditional payment methods), but it will also help build investor confidence and stabilize its prices. Perhaps it could also perform better in a crisis once that happens.
The second way for cryptocurrency to increase in value is due to excessive money printing that has been going on. Ever since the world economy went off the gold standard, governments have had full control over how much money they print. While this helps them manage the economy and provide stimulus, excessive printing can be quite inflationary. The Federal Reserve has been printing money to battle COVID-19, and high inflation in the future is not out of the question.
Due to its limited supply, cryptocurrency should store wealth quite well during times of inflation. Once again, we have yet to test that theory in the real world because inflation has been quite low across the world ever since cryptocurrency’s rise to prominence.
If conservative investors want to have a tiny bit of their wealth in a risky investment that could pay off “big time” in the future, then they should dedicate a small percentage (not more than 5%) to cryptocurrency. A large part of your crypto holdings should be in Bitcoin. However, you should also branch out to other well-known altcoins.
Those who are a bit less risk-averse have a lot more options at their disposal. They can afford to have a larger percentage of their portfolio in Bitcoins if they wish. Just remember that based on the data so far, stocks, bonds, and other alternative investments should probably still make up most of your portfolio. This is because Bitcoin has been very volatile so far, and this trend will continue due to the aforementioned reasons in the near future as well. Stocks, bonds, and other investments have proven to be safer investments in the long term, and Bitcoin has still not proven itself as a reliable store of wealth.
Lastly, it is important to once again emphasize cryptocurrency’s volatility. Those who are unwilling to withstand huge variations in its value should probably not hold a lot of it.
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