Bitcoin, A Macro Hedge?
By: Yuriy Anosov
Tags: Macro, Bitcoin, Cryptocurrency News, Galois Capital, China

Bitcoin is often referred to as a store of value that acts as a hedge against traditional asset classes during times of market stress. I thought it would be interesting to examine how Bitcoin has performed with regard to this premise. Lets briefly discuss Bitcoin dominance within the crypto space followed by a deeper look at its performance during times when markets are experiencing steeper bearish trends.

Drudging through the prolonged crypto bear market over the couple last months, traders have been rotating out of the more speculative alternative coins back to the relative safety of Bitcoin. The concept of Bitcoin dominance has been getting a lot of focus from various blogs. However, looking at the historical data for Bitcoin dominance, you will find that the recent highs of about 50% are merely highs for 2018. In fact, as recently as the retail investor driven price action of December 2017, Bitcoin dominance touched 65% on a day where BTCUSD was trading north of $16.8k. Perhaps it is false to claim that Bitcoin dominance is a characteristic of the bear market? Although, on the opposite side of that argument, it makes sense for lengthy bear markets to exhibit Bitcoin dominance because many of the other coins that were overbought during the market run-up are being flushed out, while on the other hand, during bull cycles, new technologies get hyped, money flows into these coins, which results in subdued Bitcoin dominance.

Looking at this a bit further on the chart above, we see that before 2017 it was quite normal for Bitcoin to be above the 80% level with regard to this metric. What does a high or low figure here represent then? I think that the answer is inconclusive, although I would argue that Bitcoin dominance is not a macro indicator of the health of the crypto markets as far as the currency aspect of Bitcoin is concerned, but instead perhaps it is more of a gauge of how viable the investment community perceives other alternative crypto projects. Either way, although dominance is an interesting metric that has different interpretations on the state of the crypto markets, I do not look at it as a hard-science.

What then is a good macro indicator when it comes to Bitcoin? As I mentioned, one of the characteristics used to describe Bitcoin is that it can be used as a primary store of value. The comparison that immediately comes to mind is gold and to a lesser extent, silver. Historically the two metals perform well when there is turmoil in the financial markets and get sold off when the markets are in periods of bullish sentiment. So, if Bitcoin is a true store of value it should ideally be highly correlated with the two precious metals.

The above chart shows the historical correlation of Gold to Bitcoin with the 120 day rolling correlation staying in a decently tight oscillating range. As this correlation never goes below -0.2 for any significant period of time, it may be a while, if ever, that Bitcoin replaces Gold in its entirety as a hedge against market stress. (BitMEX Research does a good job looking at Bitcoin correlations with traditional assets in this piece from November 2017). Should Gold and Silver be correlated with Bitcoin? If a larger percentage of smart money starts using Bitcoin as a macro hedge, then wouldn’t a lesser percentage of that money go into Gold and Silver? Using this logic, Bitcoin should not have a high positive correlation with the metals because it is important to look at the “store of value” asset class as one large pie, and the allocation within that pie is a zero-sum relationship. Any additional flows to Bitcoin with the purpose to hedge against a major currency selloff, would cannibalize flows into Gold or Silver intended for that same purpose.

Gold has been around and used as “money” since the ancient times, most commonly agreed upon to be around 700 B.C. during the days of the Lydian Empire, which is now geographically Western Turkey. In comparison, Bitcoin is still in its infancy, and it may take an inordinate amount of time for it to replace the functionality that is served by Gold in the financial markets.

An interesting phenomenon that is unique to Bitcoin is how citizens of a country with rampant hyperinflation have the ability to transfer their wealth into Bitcoin which is shielded from the erosion of purchasing power of the local currency and more importantly does not give the local government an easy way to prevent its citizens from transferring their wealth in this manner. The most visible examples being Venezuela and Zimbabwe.

Having said that, lets take a closer look at a few events where the markets are going through a down cycle and if there is any significant response in the performance of Bitcoin. First lets examine the market correction of the first quarter of 2016. The U.S. Federal Reserve executed the first 25 basis point rate hike since they brought rates to zero during the financial crisis of 2008 in December of 2015. The Fed then issued guidance that during 2016, it expects to issue three more 25 basis point hikes throughout the year, a view that was shared by the large majority of sell side researchers and asset managers.

From December 22nd 2015 to the end of January of 2016, the Shanghai Stock Exchange Composite Index (SSE) has lost approximately 27% of its value, triggering other shocks throughout the global markets and most notably forcing the Fed to adjust the frequency of their monetary policy tightening from the expected three hikes to only hiking once during 2016, which did not take place until December, a full year since the first hike.

Lets focus on the drop of the SSE here. During this same time period Gold increased about 4.1% while Bitcoin dropped 14.6%. It can be argued that because this SSE decline was particularly steep and occurred over a one month period, a relatively short period of time for such a broad based index, any appreciation in Gold or Bitcoin as a result of the decline would be a lagging indicator. Gold does perform as expected in this case. If we look at the six year price history of Gold starting in July 2012 going to July 2018, the biggest 120 day price appreciation is a 278 point move from January 13th to July 6th 2016. This move was generally within an elevated price level that lasted through majority of 2016 as global markets stayed depressed later in the year due to the UK vote to leave the European Union and took until the culmination of the U.S. presidential election at the end of the year to recover. Bitcoin, however, is a different story. Price action was sideways in the first half of 2016 followed by a 68% jump in June followed by a strong finish towards the end of the year 30% above the peak of the June up-move.

Staying with the SSE index, it has again been falling over the last few months, declining 17% since the United States started announcing Tariffs on Chinese goods in May. Bitcoin price performance once again did not have a distinct negative correlation with the SSE as the Bitcoin price dropped from about 8,000 to the current level of 7,200 during the same time frame. The conclusion here being that Bitcoin does not yet act as a hedge against geopolitical events that cause volatility in the macro markets the way Gold does. Even though Bitcoin does not have meaningfully high correlations with the majority of fiat currencies, commodities and other macro indexes as shown in the BitMEX research chart below, the Bitcoin price, in the current environment, is driven primarily by other factors than global macro.

Currency effects are more pronounced however than equity indexes when looking at how Bitcoin reacts to their volatility. For example, the Greek debt crisis that caused the Euro to fall in value and come close to achieving parity with the United States Dollar had a more definite effect on Bitcoin price then the SSE examples used in this analysis as well as any movement by other indexes like the S&P 500. In fact, the larger the currency, the bigger the effect of its volatility on Bitcoin.

I originally thought that the current situation in Turkey and the stress that the Lira has been experiencing over the last few months, may provide interesting observations on the Bitcoin price, but Turkey, the world’s 18th largest economy, is just not big enough on the global scale to provide any meaningful movement, especially when there was not a direct relationship between Bitcoin and the SSE which represents the second largest economy (Turkey’s 2018 projected GDP is only 6.45% of China’s).

In conclusion, I believe that it will take a more significant event, such as Italy leaving the European Union, further emerging market stress due to United States further reducing their balance sheet or something else of significant scale, before we can really judge whether Bitcoin stands up as a store of value and hedge against market stress. Bitcoin has a lot of idiosyncratic effects specific to the technological progress of the crypto markets that are weighed much higher than what is going on in the global macro environment with respect to what causes its price to move, meaning that a macro event that moves the price of Bitcoin would have to be very significant.