How does crypto react to an economic crisis?

ICONOGRAPHER
Mar 19 · 5 min read

As the global economy — and stock markets in particular — have started to tumble dramatically over the past few weeks, many cryptocurrency investors have been left scratching their heads over a similar decrease in crypto markets. This confusion is especially more relevant when it comes to Bitcoin, which was seen by many as a “safe haven” from the turmoil of our legacy financial system.

Many have been asking: “Isn’t this the moment that Bitcoin was was built for?”

After some consideration, this price decrease starts to make a bit more sense, for a few reasons.

First, in times of economic panic, there is rush toward cash. This isn’t necessarily because people and companies have found a newfound intrinsic love for the long-term value of the dollar; rather, they’re in need of liquidity. For individuals, this may be because they aren’t sure if they’ll have enough money on hand to pay for expenses over the coming months, or it may just be because they see their 401k balance falling and decide to panic sell, or a combination of both.

For businesses, this may be to create cash reserves to replace the likelihood of lost revenue over the coming weeks, or to pay off existing obligations, or any other number of reasons.

In short, without certitude regarding where tomorrow’s dollar is going to come from, business and individuals are generating dollars today by selling assets. You can’t pay your rent with stocks or with gold — you need cash.

That’s why stocks aren’t the only assett that’s decreased. Gold and bonds — both seen as “safe havens” are also down. As, of course, is crypto.

In other words, if you’re not sure that you’re going to have an income next month, your desire to hold Bitcoin (or any other cryptocurrency) falls dramatically. While the philosophical belief in HODLing may still be there, it’s going to take a back seat to the need to put food on the table.

Accordingly, as this crisis worsens — and it’s likely to get worse before it gets better — this trend might continue, bringing bitcoin and crypto to even lower prices.

For those concerned about the long-term health of crypto, just ask yourself whether or not the fundamentals of the market generally, or your favored projects specifically, have changed. For some, such as Maker DAO, this crisis may have forced you to alter your evaluation. For most others, it appears business continues as usual.

How might this play out over the coming months?

While it’s certainly hard to predict how this will play out, we can at borrow a lesson from a prior economic crisis to figure out how investors might behave.

Let’s take a look at the price of gold in the wake of the 2008 financial crisis:

Here is a chart showing the price of gold throughout 2008. Although the tremors of the financial crisis had been felt through the second half of 2007, the more accurate “beginning” of the crisis was the collapose of Bear Stears in March 2008. As you can tell from the chart, gold peaked at this moment.

From that point through October, the price of gold fell from just under $1,000 to a bit more than $700. Despite significant financial turmoil in the markets, the price of gold fell dramatically, hitting bottom just around the time that the financial bailouts went into effect.

Why did this happen?

As alluded to in the beginning of this post, individuals and businesses needed liquidity in the form of cash. Not only did this force them to flee from other assets, but it also created an increase in demand for the U.S. dollar, leading to an increase in the value of the dollar. That means gold prices denominated in USD would need to fall as the value of the dollar increased.

So we now have dollar appreciation and a corresponding gold depreciation in dollar terms, combined with additional gold depreciation through people selling gold in order to acquire USD for liquidity purposes.

However, as you can see from the chart above, the price of gold did eventually increase. In fact, here’s how the next couple of years played out:

As you can see, the price of gold more than doubled, hitting local peak of $1,800+ in less than two years, which was more than a 100% increase from the low in October 2008.

While the immediate crisis in 2008 created a shortage of dollars due to an increase in demand, the subsequent government actions via monetary action (lowering of interest rates, TARP, quantitative easing, etc.) created a surplus of dollars. This led to a deprecation of the value of the dollar and an increase in the value of gold.

Meanwhile, after the immediate crisis passed, the demand for short-term liquidity subsided as well, giving individuals and businesses a chance to start investing in less-liquid assets again, including gold. Of course, economic growth was still slow and many were forced to remain on the sidelines until their economic situation stabilized, but the overall trend was far better (from a liquidity standpoint) than it was in the immediate 2008 crisis.

Now, you might be wondering why I’m spending so much time talking about gold in a post about cryptocurrency.

Since Bitcoin didn’t exist until after the peak of the financial crisis, it’s hard to tell how it will perform during this one. Since many believe that Bitcoin may someday supplant gold as the go-to “safe haven”for many, I felt it might be helpful to look at how gold has behaved in the past.

With gold’s dramatic slide in price — as well as Bitcoin’s — over the past couple of weeks, there’s a chance we may be playing out a similar situation as 2008.

It’s possible we will see the price of gold decrease more as the crisis worsens, followed by an increase over the following months as the government injects liquidity into the economy.

The question then becomes: will Bitcoin follow the same pattern?

With the halving on the horizon as well, the next few months could be very interesting for Bitcoin and crypto as a whole.

ICONOGRAPHER

Written by

ICON contributor and analyst, ready to hyperconnect the world. Twitter: @iconographerICX

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