Bitcoin: Your New 'Safe Haven'
On Monday morning, North Korea’s Foreign Minister accused the United States of declaring war after President Trump tweeted that North Korea "won't be around much longer." This hawkish rhetoric caused investors to sell stocks and move into "stores of value" such as cash, gold, and somewhat surprisingly, Bitcoin.
As the name implies, a store of value is any asset that can be saved and usefully retrieved at a later time. Anything can act as a store of value as long as such thing retains its value and can be exchanged for equal or greater value in the future. Perception is a key factor: The more an asset has acted as a store of value in the past, the more likely investors will flock to such asset in times of trouble and push its value higher; and this behavior becomes self-fulfilling.
Cash is the most common store of value, but its purchasing power can be eroded by inflation in the costs of goods and services. If you keep cash buried in a bank account or in the backyard, you expect it to buy the same amount of goods when you go dig it up, adjusted for inflation. As the global reserve, the U.S. dollar is the most popular store of value, offering access to the most liquid securities markets and backed by the “full faith and credit” of the U.S. government.
Gold is another common store of value, used to protect against inflation. Since the supply of proven gold reserves in the world is finite, gold should increase in value with an increase in the amount of paper money in circulation. Moreover, the cost of extracting the yellow metal from the ground gives it a scarcity value.
And now, in the past year, investors are increasingly looking to Bitcoin as a store of value in uncertain times. In 2009, in the middle of the biggest financial crisis of the past century, the cryptocurrency's arrival was lauded by early enthusiasts as an alternative to fiat money systems.
Similar to gold, Bitcoin is digitally mined, and this process requires a significant computational investment. Bitcoin’s underlying protocol creates an artificial scarcity by limiting the number of coins in circulation to 21 million, and the amount of tokens that can be mined is decreased by half approximately every four years. At current rates, this finite supply of cryptocurrency will be reached at around the year 2140.
In the past six months, three sharp increases in S&P 500 volatility (as measured by the VIX, Wall Street's "fear index") have coincided with rising prices of Bitcoin.
In April, a period of elevated S&P volatility tipped off a Bitcoin rally from $1,250 to $1,850 for a 48% gain. Soon thereafter in May, another spike in S&P volatility coincided with a jump in Bitcoin from $1,750 to $2,770. More recently, in August, spiking volatility again served as the backdrop for a Bitcoin move from $3,360 to $4,300. And Monday's North Korea news tipped off a $200 rally, moving Bitcoin up 5% in about 30 minutes.
Critics of Bitcoin’s store-of-value functionality point to its ability to “hard fork,” a process in which developers digitally clone a cryptocurrency to improve existing functionalities and thereby create a new token. The concern is that more cryptocoins with Bitcoin’s functionality will dilute existing supply, precipitating a drop in prices. This recently happened as Bitcoin’s recent hard fork produced Bitcoin Cash on Aug. 1. But fears that investors and miners will move to the new network subsided as Bitcoin has risen 44% since the new clone arrived.
Another key factor of a store of value is price stability. Even though Bitcoin has risen fourfold this year, price volatility has been declining since the first coin was mined. Just a few years ago in 2013, daily price moves of 20% were the rule, not the exception. Nowadays, the standard deviation of daily returns has remained under 5% for most of the past two years.
While Bitcoin’s standard deviation of daily returns is twice that of gold, volatility has been decreasing steadily as cryptocurrency becomes a more widely accepted technology. The rise of the cryptocurrency ecosystem has provided investors over 900 new tokens to diversify their crypto holdings among coins with different digital functionalities. Additionally, the pool of investors is rapidly growing at a rate of 25,000 new wallets per day, according to blockchain.info.
The Bottom Line
In times of market uncertainty, investors are increasingly turning to Bitcoin. And if they are consistently rewarded for seeking the cryptocurrency as a store of value, the behavior becomes self-fulfilling and increases the likelihood it will continue.