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Hedging Against Global Uncertainty with Crypto |
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16th Jun 2020

Hedging Against Global Uncertainty with Crypto

Due to their uncorrelated nature with fiat economies, cryptocurrencies have been considered safe haven investments during times of economic uncertainty. Bitcoin, in particular, due to its scarce nature, is considered a hedging tool against rising inflation. One of the most basic hedging techniques is diversifying the investment portfolio. This is where cryptocurrencies can help by reducing risk exposure, should any one asset decrease in value. 

But how uncorrelated are cryptos? The initial onslaught of the pandemic-induced market volatility painted a different picture for forex and cryptocurrency traders. 
The rising coronavirus cases in Q1 2020 created uncertainty and panic in the global financial markets, resulting in record drops in major indices. Quite unexpectedly, on March 12, 2020, Bitcoin registered its steepest decline in seven years, reflecting the broader decline in the stock markets, amidst a massive sell-off. The position of cryptocurrencies as a hedge against volatility and economic downturns looked tenuous.

However, in subsequent months, crypto prices climbed higher. By May 2020, Bitcoin trading volume reached a new high since 2018, on major exchanges, at $2-$3 billion per day. By Q2, BTC price was up 34% since the start of the year. 

Expert analysts maintain that the decline in the earlier part of the year was only due to the unprecedented nature of the COVID-19 crisis. Traders sought liquidity, amidst the global pandemic, and short-term institutional traders made high value withdrawals out of exchanges. The trends have reversed and BTC has mostly stayed above the $9,000 mark since May 2020, crossing the $10,000 mark on June 2. 
In times of growing economic turbulence, such as the pandemic, there is growing consensus that assets like BTC can be considered a flight-to-safety investment.

Here are some reasons why:
In trading forex or bitcoin, the Swiss Franc, Japanese Yen, US Dollar and gold are considered safe haven investments. Gold bullion or gold ETFs are popular ways for investors to park funds in times of policy uncertainty and rising inflation. According to a study by the Department of Economics of the University of Pretoria, Bitcoin is a hedge against extreme market events, both stock market crashes and booms. This is based on the theory of correlation of “extreme returns.” Moreover, the correlation between gold and Bitcoin is very low. This makes them perfect complements in investment portfolios, during economic volatility, geo-political risks and fluctuations in speculative sentiment.
Central banks worldwide are resorting to lower interest rate regimes to push money into their respective economies. These unseen levels of de facto monetary financing and quantitative easing to “infinity” could lead to high inflation for global economies. Moreover, it will unsettle investors, causing wild fluctuations in the bond and stock markets. 

The supply of coins like BTC is limited, with it capped at 21 million. With the May 2020 halving event, the rate that it is released into circulation has been further slashed to 6.25 BTC for every mined block. BTC, as an investment, could act as a hedge against inflationary pressures. 
The risk of transmission of COVID-19 through paper currency is high. In this scenario, digital currencies stand a chance to replace physical money, especially with huge advancements in the DeFi (decentralised finance) sector. In the beginning of 2020, the DeFi sector surpassed $1 billion in market size.

The need for cheaper, easier and faster access to financial services will increase in the coming years, especially if social distancing persists and job losses reduce household incomes.
The crypto market is starkly different today from the 2017 ICO mania. There have been huge improvements in the applications developed, in terms of user interface and experience. Liquidity is higher, the token mining sector is industrialising, and regulatory frameworks for exchanges and service providers are robust. Moreover, there is a plethora of derivative instruments, like BTC CFDs, futures and more, for trading cryptocurrencies.

Exchange platforms, like Coinbase and Binance, have reported huge surges in deposits, after the $1,200 stimulus cheques were provided to millions of US citizens in April 2020. This shows increasing interest in crypto trading as an alternative investment vehicle. 

Both forex and cryptocurrency trading require a cautious approach. Bitcoin is driven by supply/demand considerations. Risk management tools are essential.