Much like its creator Satoshi Nakamoto, whose identity remains unknown, Bitcoin has been quite the mystery for investors since its creation in 2009. Peaking at over $73,000 mid-March what explains the motivations behind these huge spikes in price? On one hand, bitcoin can be viewed as a ‘risk-on’ asset: despite high volatility its substantial returns correlated with broader bullishness in the rest of the market. Alternatively, some argue that bitcoin can act as a ‘risk-off’ asset similar to precious metals that traders have historically hid in during times of economic uncertainty or market turbulence; leading some to dub it as ‘digital gold’.

Due to its unpredictability and volatility bitcoin is a ‘Schrodinger’s asset’ of sorts, existing in a superposition between many explanations for its price movements. Is bitcoin an effective hedge against inflation and instability? Or are recent rallies fuelled by broader bullishness in the market? Does bitcoin have the maturity to be considered ‘risk off’ by the market?

Bitcoin as a ‘Risk Off’ Asset

As bitcoin gains more legitimacy larger players are becoming more interested in the value of this relatively young and arguably still yet unproven asset. There are two arguments for bitcoin as a ‘risk off’ asset: Bitcoin as an ‘instability hedge’ and Bitcoin as an ‘inflationary hedge’.

Bitcoin’s decentralised nature could reinforce claims that it can be used as a hedge against instability in traditional financial systems and markets. Ark Invest’s CEO Cathie Wood argues that “massive currency devaluations” like the slashing of the Nigerian naira and the Egyptian pound are fuel on the fire for rises in bitcoin’s price, prompting a flight to safety into the decentralised value store. The argument here is that because bitcoin is not tied to the security of one centralised financial institution that it does not have the same counterparty risks associated with bodies like the central banks of Nigeria or Egypt. Another example where we see this kind of instability hedge in action for Bitcoin in action is when American regional banks imploded March 2023; during this period bitcoin went up 40%. A far-fetched correlation to draw? It’s certainly hard to imagine that if BlackRock, a massive bitcoin buyer and market maker for the Bitcoin ETF, suffered the same structural failures, it would result in any upside for the cryptocurrency.

Meanwhile inflation is proving persistent; this could be another explaining factor behind Bitcoin’s gains. Higher inflation combined with excessive fiscal loosening provides the basis for the so-called ‘debt debasement’ trade. Zach Pandl, managing director of research for digital-currency asset manager Grayscale Investments told The Wall Street Journal that “yes”, bitcoin could be effectively used as inflation hedge. Pandl argues that one factor making bitcoin an excellent inflationary hedge compared to gold is its ‘guaranteed scarcity’. Pandl argues that while the total bitcoin is transparently available on a public ledger, conversely, “the absolute amount of gold that will ever exist is unknown”. One research paper claims that there is evidence to support bitcoin as “an inflation hedge but not a safe haven”. The Vector Autoregression (VAR) model used in the study found that “bitcoin appreciates against inflation (or inflation expectation) shocks”. Not so clear cut though, the study also found that unlike gold, bitcoin price movements tended to decline with “financial uncertainty shocks” making its status as a safe haven asset less certain. bitcoin is full of these contradictions and uncertainties – the fact remains that without a proven track record the market remains somewhat skittish when it comes to placing their faith in bitcoin in the long term.

Bitcoin as a ‘Risk On’ Asset

At its latest all-time high in mid-March bitcoin was up over 300% since lows at the beginning of 2023 – in the same time period the S&P 500 was up 33%. Although there was outperformance by a factor of nearly 10, could the similar positive price movements suggest a correlation for bitcoin as a ‘risk on’ asset rather than a ‘risk off’ one?

Kevin Davitt, the Head of Options Content at Nasdaq, highlighted the notable, though occasionally disrupted, correlation between bitcoin and the Nasdaq 100 Index (NDX) sat at 0.805 in January. This figure suggests a relatively strong correlation; however, instances of divergence are also not uncommon. Specifically, Davitt pointed to late 2019 and mid-2021 as periods where the correlation broke down, dropping to -0.65 in 2019. During these intervals, an inverse movement pattern was observed between the NDX and spot bitcoin prices. Davitt elaborated that such negative correlations typically emerged in the wake of significant downturns in bitcoin’s value. Correlations would suggest that bitcoin can be viewed more as a ‘risk on’ asset, particularly in times where the stock market is rallying, but things with the volatile cryptocurrency are never quite that black and white.

Although billions of dollars of bitcoin are being bought by financial institutions like Grayscale, BlackRock and Fidelity, one of the largest players flying in the face of inflationary and instability hedge explanations for bitcoin surges are still major central banks. Although there are some exceptions (i.e. El Salvador) central banks and governments seem largely unconvinced by bitcoin’s potential as a ‘risk off’ asset. CryptoQuant Head of Research, Julio Moreno says Central Banks Will Be the ‘Last to Join the Party’ in buying bitcoin, assuming it happens at all. ‘The ECB is very unlikely to ever buy bitcoin’, according to central bank board member, Isabel Schnabel. Some speculation was made that China could secretly be holding over $6 Billion in cryptocurrency after seizing them in 2019 but on the surface the Chinese government is staunchly anti-crypto – making all cryptocurrency transactions illegal a few years ago. No buy in to the ‘digital gold’ narrative from centralised banking This reluctance to adopt bitcoin all occurs while both the ECB and the Central Bank of the People’s Republic of China buy gold in near record and amounts respectively. Goldman Sachs explains the continued commitment to buying such large quantities of physical gold as a function of a “major risk-off event”; This could be viewed as a confirmation that central banks still perceive Bitcoin as a ‘risk on’ asset.

Corroborating major central banks perspective on the digital currency Cornell University professor of trade policy Eswar Prasad argues that bitcoin cannot be used as a store of value or an inflationary hedge because “there is no intrinsic value for bitcoin”. He goes on to state that this is “because it’s a purely speculative financial asset,” and that, “there’s no valuation model” for bitcoin. Lacking the track record of gold which has been considered valuable as far back as 3100BC in Ancient Egypt, perhaps bitcoin simply lacks the maturity and historical confidence to be considered ‘risk off’ by the mainstream just yet.

Reference:

Bitcoin price hits all-time high of over $73,000 (yahoo.com)

Cathie Wood Attributes Bitcoin’s Rise to National Currency Devaluations (yahoo.com)

Has Bitcoin Benefited From the Banking Crisis? Not in the Way Its Fans Hoped. – The New York Times (nytimes.com)

Is Bitcoin an Inflation Hedge? Here Are the Arguments on Both Sides – WSJ

Bitcoin: An inflation hedge but not a safe haven – ScienceDirect

Zachariah Walker

Content Writer at Finalto

All opinions, news, research, analysis, prices or other information is provided as general market commentary and not as investment advice and all potential results discussed are not guaranteed to be achieved. The information may have been derived from publicly available sources, company reports, personal research, or surveys. Past performance is not indicative of future performance. Trading carries risk of capital loss. Service available to professional clients only.