Bitcoin — An Emerging Safe Haven?

-by Aditya Jalan and Raghu Yarlagadda from FalconX.

Abstract:

Bitcoin price speculation and volatility has been the talk of the town ever since the cryptocurrency was born. However, with growing institutional interest in this space and call-outs of Bitcoin as an emerging asset class, questions like the following have become pronounced — “Is Bitcoin really a speculator’s playground? Or is it, just like any other asset class, impacted by the broader macroeconomic and geo-political environments?” “Is it worth considering Bitcoin as an asset class?” “Is it possible to understand and anticipate price movements?”

While answering these questions in their entirety might not be possible at this stage, we try to put forward our views on the answers to some of these questions in this article. Our analysis reveals that over time, cryptocurrency prices have become increasingly responsive to the overall macroeconomic environment. It seems that, in general, Bitcoin prices moved up significantly as and when markets around the world sensed economic and geo-political noise. One might extrapolate this to understand that investors have considered allocating at least some part of their portfolios to Bitcoin as traditional markets appeared tense. Further, a low correlation to most traditional asset classes and an increasing one to gold amplify the portfolio diversification benefits offered by Bitcoin. A closer look at the adjacency of Bitcoin and gold price reactions to significant announcements relating to the ongoing U.S.-China trade war implies that market participants, just like those in the world of traditional asset classes, should be more aware of the broader macroeconomic and geo-political situation around the world in order to time their trades efficiently.

Global markets are currently dominated by unprecedented levels of uncertainty, and this trend is growing. We see this clearly via three key macro indicators.

First, two of the largest economies in the world have been embroiled in a bitter trade war over the past year.¹ Back and forth tariff impositions have hurt businesses worldwide and created serious concerns for global financial markets.

Second, with over $17 trillion in negative yielding bonds², bond yields across the world have plunged to 120-year lows. Seasoned investors and economists are ringing “bond bubble” alarm bells. These bells are certain to get louder as more and more investors realise that over 30% of investment grade securities globally now bear negative interest yields, guaranteeing that bondholders will lose their money if held to maturity. What is scarier is that investors continue to go long these bonds, maybe with the hope of further price increases (a fatter bubble) or due to the fear of losing more elsewhere.

Third, this is happening at a time when global economic slowdown is well and truly real as evidenced by key economic data published by all major economies³. Further, geopolitical tensions have continued to surge in Europe, the Middle East, and Americas amidst a messy and prolonged Brexit, escalating tensions between US & Iran, persisting threats of terrorism and the recent oil supply concerns.

The current macro context presents a unique lens through which we may evaluate how cryptocurrency performance is correlated with major macro trends. Are cryptocurrencies a good solution to the heavily centralized monetary and banking systems around the world, which many believe to be the cause for the mess which economies find themselves in every few years?

Instead of generalizing the trend of Bitcoin’s price movement over the period where we have seen macroeconomic conditions worsen, we believe it would be much more interesting to see the specific price movements during points in time when some of these major events happened.

To identify and closely monitor such trends, we took the Bitcoin daily price chart from Coinbase and a timeline for some of the significant macroeconomic events mentioned above. We then tried to put the two together to see how Bitcoin moved as these events unfolded.

On each of the charts below, the vertical lines correspond to dates of significance with respect to these events and the area in between these lines show how Bitcoin prices reacted to these events on these dates. For simpler visualisation, the areas with an upward trend in Bitcoin prices have been shaded in green while those with a downward trend are in red and a neutral stance is indicated by yellow.

On the first chart, we mark Bitcoin price reactions to announcements of strategic importance relating to the US-China trade war this year. It can be clearly seen that as the trade war escalated and spooked investor sentiments in global financial markets, Bitcoin prices observed an apparent upsurge.

Following this up with a similar analysis on Bitcoin price movements during major Brexit related announcements this year, we see that Bitcoin prices rose as Brexit unfolded into what many have called out to be a major political drama in the UK.

Amidst indications of a major economic slowdown in the United States, the Federal Reserve has largely adopted a dovish stance over the course of the year. The following graph shows that Bitcoin has apparently benefited from this indicating a probable growing safe haven demand for the cryptocurrency.

It seems that, in general, Bitcoin prices moved up significantly as and when markets around the world sensed economic and geo-political noise. One might extrapolate this to understand that investors have considered allocating at least some part of their portfolios to cryptocurrencies as traditional markets appeared tense, indicating a rise in a gold-like safe haven demand for cryptocurrencies amidst a global economic slowdown.

This evident correlation between cryptocurrency demand and economic anxiety is in fact not just restricted to this fiscal. Going back in time and extending this analysis to events unfolding during the actual Brexit referendum process and the US Presidential Election of 2016 shows very similar results, as Bitcoin spiked immediately after these events, even as traditional markets appeared sluggish.

While it might be intuitive to some as to why investors seem to be turning to crypto at a time when the prospects of an underwhelming economic future loom large, we decided to statistically analyse this further and check how crypto has fared over the past couple of years under varying market circumstances.

For the purpose of this analysis, we have taken major asset classes’ performance as a proxy for economic performance and tried to visualize the correlation between cryptocurrencies and other asset classes through scatter plots with trend lines which are well supplemented with analysis of R² values.

• R², known as the coefficient of determination, is a statistical measure which indicates how well can the variance in values of one variable be explained by the other variable in a regression analysis.⁴ Put simply, it explains what percent of the data fits the best possible model (given the series of values of two variables), hence also known by the name “goodness of fit”. R² values can range from 0–1 (0% to 100%), wherein a higher value would mean stronger relationship between the two variables.
• For example, while regressing a stock’s return with that of an index, a higher R² would mean that a high percentage of the stock price move can be attributed to the index move, whereas a lower R² would mean otherwise.
• The returns for all assets have been calculated as follows:

Return= Price(t)-Price(t-1)/Price(t-1)

The trendlines and the R² values on each of the scatter plots clearly narrate the relationship between Bitcoin and the corresponding asset classes.

• Since the R² values are extremely low (well below 1% in all cases), it implies that the variance in returns of Bitcoin is not at all explained by the other corresponding asset class, thus creating a strong case for inclusion of cryptocurrencies while creating a well-diversified portfolio as the basics of portfolio management suggest creating a portfolio of lowly correlated assets so as to minimize portfolio risk and maximise returns.
• By proving that cryptocurrencies do not move along with the other asset classes, this analysis creates a case for cryptocurrency to emerge as an asset class which can help diversify a portfolio of traditional asset classes and hence prove valuable in times of market uncertainty.
• Thus, the findings from this analysis align well with our earlier observations where we hypothesized increased investor interest in cryptocurrencies during times when traditional markets appeared fragile as an indicator of its potential safe haven properties.
• While the analysis reveals an extremely weak relationship between Bitcoin and traditional asset classes, another interesting point to note here is the relatively stronger correlation it holds with Gold — a safe haven asset that has been enjoying investors’ trust for decades. Bifurcating the analysis period into two– (i) with returns over the past two years (ii) with returns over the past year only, further indicates that this relationship has become even stronger in recent times with R² increasing ~4x:

Despite a weaker R² in absolute terms, the observation that Bitcoin’s movements have started to resemble those of gold much closer in recent times does suggest that investors have started looking towards this space as a safe haven asset.

This is further accentuated if we study the trend of correlation between Bitcoin and Gold during this analysis period.

This increased correlation is much more evident when the markets sense some real macroeconomic or geopolitical noise. This is clear from the below comparative analysis of Bitcoin and gold returns on days following major announcements on the US-China trade war front, wherein we observe that Bitcoin and gold moved in the same direction further substantiating the case of Bitcoin being increasingly viewed as a safe haven asset by investors.

It might not be possible to predict where Bitcoin’s price is headed but each of our analysis clearly signals that Bitcoin is gaining mainstream attention as an asset class which institutions are increasingly looking to evaluate. How this space eventually evolves as institutional interest peaks and more products emerge is something that remains to be seen. But there is one thing for certain, cryptocurrency as an asset class has arrived and hence its pricing is no longer based on just momentum driven or speculative trading. In fact, it is becoming increasingly responsive to broader macroeconomic events and this is something that will be fascinating to follow.

Sources/References:

• Timelines of major macroeconomic events in 2019 for analysis of Bitcoin price reaction:
• https://www.china-briefing.com/news/the-us-china-trade-war-a-timeline/
• https://researchbriefings.parliament.uk/ResearchBriefing/Summary/CBP-7960#fullreport
• https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
• Bitcoin Historical Price charts : https://in.tradingview.com/
• All Asset Classes’ Historical Return Data:
• https://finance.yahoo.com
• www.investing.com

All Scatter plots, the Bitcoin vs. Gold Rolling Correlation Chart, and the chart showcasing Bitcoin vs. Gold returns during US-China Trade War are an output of FalconX’s proprietary analysis.

Footnotes:

[1] https://www.bbc.com/news/business-45899310

[2] https://www.bloomberg.com/graphics/negative-yield-bonds/

[3] https://www.forbes.com/sites/greatspeculations/2019/09/22/a-strange-new-world-economic-slowdown-liquidity-issues/#7cebb59189ff

[4] https://www.investopedia.com/terms/c/coefficient-of-determination.asp

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