The performance of bitcoin and gold both decoupled from other asset classes and boomed during 2020 as economies booked their worst falls since the Global Financial Crisis. With bitcoin now leaving gold in its wake this year, will it become the favoured hedge of the future?
Having limited correlation with other asset classes, bitcoin joined gold in acting as a diversifying asset for investors seeking opportunities during a time of uncertainty.
Now sitting at a valuation almost ten times the level of where it was 12 months ago, it would be hard to deny that volatility in the ‘old economy’ had not worked in the crypto’s favour.
“All other traditional asset classes are getting more and more correlated during downturns,” Tancredi Cordero, founder and CEO of Kuros Associates, said at ETF Stream’s Big Call: Thematic ETFs event. “Even when growth equities had their recent downturn, this did not directly correlate in bitcoin and this showed its potential diversification benefits.”
With bitcoin posting uncharacteristically steady growth during the first eight months of the pandemic, the asset’s value shot up during the final two months of 2020 as discussion of institutional involvement provided a strong basis of validation. In fact, whale wallets – those holding more than 1,000 bitcoins – bought 731,000 tokens during the final week of December alone.
As well as offering a source of support for valuation spikes, talk of professional backing helped bring bitcoin into the mainstream news cycle, and emboldened those making comparisons to gold.
Alongside its role in portfolios during the pandemic, bitcoin also shares some inherent characteristics with the yellow metal.
For instance, both enjoy strong liquidity and benefit from their status as finite commodities. This second quality is what enables them to act as a hedge – with their scarcity allowing their values to remain at least roughly steady even as inflationary pressures mount amid widespread money printing.
Digital and physical pickaxes cut different shapes
While sharing gold’s role as a hedge to broad disruption, it is important not to mistake the main source of bitcoin's recent momentum. Whereas gold consistently observes the pattern of ticking upwards when cyclical equities suffer, investors should view the pandemic economic cycle as more of a catalyst than a primary cause of bitcoin’s current surge.
Though bitcoin certainly shared gold’s role as a hedge during 2020, the main thing the pandemic achieved was bringing the crypto back into the public spotlight. From there, news cycle prominence – including coverage of professional backing and a sizeable investment by Tesla – and investor belief have been the key drivers behind bitcoin’s current valuation.
In fact, completely undermining the volatility hedge narrative, the majority of bitcoin’s price gains have been made since Pfizer’s vaccine results sparked hopes of an economic recovery last November.
Anaelle Ubaldino, head of ETF research and investment advisory at TrackInsight, said: “Currently, the status of bitcoin as a safe haven is not generally accepted.
“Investors fleeing stocks are not turning to bitcoin as much as to gold, so normality returning in the stock market is likely to have less of an impact on the price of bitcoin than on gold.”
Further illustrating this departure from the economic contrarianism of gold, bitcoin exchange traded products (ETPs) collected $1.3bn in new assets during Q1 2021. Meanwhile, gold ETPs saw a $10.9bn asset exodus, according to data from TrackInsight.
Overall, the average gold ETP saw $115m outflows during the first three months of the year, while the average bitcoin ETP saw $109m inflows. During March alone, bitcoin ETP assets under management (AUM) rose by 35%, to a total of $6.7bn.
Crypto undermined by its youthfulness
Another distinction is that with gold having been used for 5,000 years and bitcoin for just over a decade, the latter is probably too new to be awarded the same definition of ‘safe haven’ as its more long-standing counterpart.
While haphazard regulation efforts and the arrival of institutional-grade products are reducing the opportunity for nefarious activity, ledger anonymity offers scope for money laundering. Likewise, although exchanges have become more sophisticated in recent years, some will still remember landmark events such as hackers stealing $460m in bitcoin from the Mt. Gox crypto exchange in 2014.
There are also fears that the significance of initial institutional involvement has been overstated.
As said by JPMorgan in a report at the start of the year: “We believe that a significant component of last year’s institutional flows into bitcoin reflect speculative investors seeking to front run other more real-money institutional investors.”
Supporting this, two of the most popular mechanisms used by institutions to track bitcoin’s performance were funds and futures contracts.
Of those investing in funds, the largest holder of the popular Grayscale Bitcoin Trust (GBTC) at the time of the JPM report’s publication was the ARK Next Generation Internet ETF (ARKW) – a speculative strategy betting on disruptors.
Likewise, coinciding with the start of bitcoin’s recent bull run, the number of bitcoin futures multiplied by a factor of four between the start of November and the end of January.
“The frothy positioning in bitcoin futures is one manifestation of this speculative institutional flow,” the JPM report added. “Indeed, bitcoin futures, the preferred vehicle of speculative investors, saw a sharp increase in open interest.”
What does bitcoin offer?
Still more established with retail and millennial investors, bitcoin may well offer a hedge during periods of uncertainty, but its role is far more nuanced than just being ‘virtual gold’.
For one, the crypto’s price is far more volatile than that of gold, and its forecast is less clear. Indeed, at the same time as JPMorgan’s gauges of ‘mean reversion’ for the asset were at record highs, the company also had a bitcoin target price of $146,000 – more than double its current level.
Aside from being used as a buy-and-hold asset, the future could see bitcoin assume practical roles in virtual payments payment. This of course assumes bitcoin will remain among the frontrunners in crypto in the long run.
For the foreseeable future, bitcoin investment offers a way of betting on its favour among investors and wider society, at least as much as it offers the hedging opportunities of assets such as gold.
Offering a positive conclusion, Jason Guthrie, director of capital markets at WisdomTree, said: “Comparisons to gold might constrain the range of what bitcoin can do.”
“We are still in the early days of the crypto story, but a lot of the early criticisms are beginning to fall away.”
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