Since the COVID-19 pandemic hit the Western hemisphere, many individuals and retail investors have flocked to the digital currency market.
So much so, in fact, that even after Bitcoin dropped by over 30 percent on March 12 alongside most equity markets, the digital asset managed to recover almost entirely and is now trading at pre-COVID prices. Since the start of 2020, Bitcoin’s valuation has even increased by more than 25 percent.
In spite of these impressive numbers, there is considerable debate surrounding the viability of Bitcoin and other cryptocurrencies during times of crisis, such as the one we face right now in the wake of COVID-19. However, given that the asset class was designed specifically to withstand such events, let’s use this article to discuss economic crises of the past and whether new investors should view the ongoing COVID-19 pandemic as a cautionary tale or an unprecedented investment opportunity.
What Crypto Learned From the 2008 Financial Crisis
Most banks around the world practice fractional reserve banking, a centuries-old practice of lending money they receive from customer deposits to borrowers. Only a small fraction of the deposits are withheld in the event that customers need to withdraw their funds. In the early 2000s, many banks in the United States began giving out mortgages to less than ideal candidates, eventually making it easy for anyone to request a loan and buy a property.
However, by 2008, a large number of these subpar borrowers became delinquent and unable to pay back their loans. When the banks took ownership of their properties, the housing market began collapsing from the inflated supply. In the end, banks were left with large, immovable properties instead of liquid assets and hard cash. This led to the downfall of many financial institutions as they failed to repay customers that had placed their trust and life’s savings in them. In addition to banks, government-backed fiat currencies also started losing credibility in the eyes of the public.
The cryptocurrency asset class was born in the aftermath of the 2008 market crash. The world’s first digital currency — Bitcoin — was released amidst government bailouts, not unlike the controversial ones we just witnessed in 2020.
Within the first-ever Bitcoin block mined in 2009, the cryptocurrency’s creator Satoshi Nakamoto included the following headline from British newspaper The Times — “Chancellor on brink of second bailout for banks.” The inclusion of this text, according to many, is proof that Bitcoin was designed to protect its users’ wealth, unlike the modern banking system.
Cryptocurrency prices are determined solely by the economics of supply and demand. Since major digital assets, including Bitcoin, have a fixed supply, increases in demand correspond to price movements as well. A government cannot simply ‘print’ more Bitcoin to meet its needs or hand out corporate bailouts; neither can it siphon or devalue existing tokens in the form of inflation. To understand how effective this approach is in real-life, let’s take a look at two instances of faltering economies where crypto has not only survived, but thrived.
How Hyperinflation Fueled Crypto Adoption
Bitcoin’s ace card over other hedge assets such as gold has always been its ability to act as a drop-in replacement to fiat currencies. In stark contrast to precious metals, individuals, businesses, and corporations can immediately begin using digital currencies for payments and trade in the event of a global economic crisis. This means that Bitcoin affords its users a level of flexibility and usability simply unparalleled by immovable bullions or paper gold contracts.
For evidence that cryptocurrencies can be extremely effective in times of crisis, look no further than Venezuela and Zimbabwe, two nations that have been reeling from the effects of hyperinflation and poor monetary policy. At the end of 2008, inflation in Zimbabwe hit a record 157 percent, making a single US dollar worth as much as 2.6 trillion Zimbabwe dollars. Venezuela’s situation was far worse, with the country recording an inflation rate of 1,700,000 percent in 2018.
Before cryptocurrencies became common knowledge, citizens of both these countries had no option but to rely on a limited number of foreign banknotes to facilitate commerce. However, with the imposition of international trade embargoes in Venezuela and a subsequent dwindling supply of banknotes in Zimbabwe, these approaches became increasingly untenable, especially for the masses.
Consequently, during a time of unprecedented economic crisis, citizens of both countries turned to the cryptocurrency asset class for settling transactions and payments. Unlike the rest of the world where trading platforms are the norm, government restrictions meant that individuals were forced to use peer to peer trading platforms to buy, sell, and exchange their holdings. In spite of that, trading volumes remained stronger than ever. As a result, prices skyrocketed within a matter of days. Even months later, Bitcoin continued to trade at a price premium compared to international prices.
Both regions stand testament to the fact that the crypto asset class can thrive even in the most dire of circumstances, thanks largely to the lack of central authorities and third parties.
How Do You Trade Crypto During a Crisis?
It is clear that there is value in an asset class that is uncorrelated to other markets. In the event of a catastrophic collapse, which some economists are concerned may be a likely reality, a separate asset class can act as a strong hedge.
That being said, cryptocurrencies remain a challenging prospect for most, and there is even more reason to follow basic investment principles. The fundamentals remain the same, as one must never invest more than one can afford to lose.
From a high-level perspective, investing in cryptocurrencies for the purpose of hedging is best compared to value investing. An investor must examine the assets that have stood the test of time, of which Bitcoin remains the most prominent.
Cryptocurrencies are volatile by nature, and during a crisis, this stands out more. Despite being largely uncorrelated to other asset classes, cryptocurrencies have their own market influences affecting it. During a crisis, it is especially important that the investor approaches investment from a long-term value perspective.
For the moment, the best approach would be to invest in major assets like Bitcoin and Ethereum (no more than can be afforded to be lost), perhaps at a portfolio allocation of 5–20%, depending on risk appetite. Setting aside some funds for cryptocurrencies every month is another reasonable option to mitigate some of the highs and lows that the market can swing between.
As more evidence of Bitcoin’s legitimacy, even the professional parties are joining in. Publicly traded business intelligence company, MicroStrategy, has invested $250 million into Bitcoin, gold, and alternative assets. Clearly, there’s a need to hedge. CEO Michael J Saylor pointed to macro economic factors that demanded diversification.
He also said that Bitcoin is a “legitimate investment asset, dependable store of value and an attractive investment asset with more long-term appreciation potential than holding cash.” The press release bursts with praise for Bitcoin.
The Future of Cryptocurrencies
As the threat of COVID-19 diminishes over time, it’s entirely possible that the equity and crypto markets will both continue their upward trajectories once again. Investors that entered the market sometime during the 2007–08 economic crisis, for instance, saw their investments triple and even quadruple over the subsequent decade. The cryptocurrency market saw an even more explosive growth in the years leading up to 2017, rising to a valuation of around $750 billion at its peak.
While crises often paint a picture of impending economic doom and uncertainty, the truth is that — given enough time — they are always followed by periods of unprecedented growth. Between The Great Depression, the Dotcom bubble, and the 2007 mortgage fallout, there is plenty of historical precedent to support that statement.
Now that markets are trading at relatively subdued levels, those entering new positions today will likely be at an advantage to investors that joined the fray a year or two earlier because the biggest market drops already took place in March and April.
To those looking to take advantage of this short investment window, crypto exchanges like Binance, Bitfinex, Kraken, and Overbit offer industry-leading margin trading platforms. However, their availability in your region may be restricted.
Regardless of the trading platform you select though, the future of the cryptocurrency market appears to be incredibly promising. Since the start of 2020 alone, Bitcoin’s valuation has jumped from $7,000 to $12,000 in August. With global financial markets posting incredible recoveries, it’s only a matter of time before crypto follows suit as well.