The Coronavirus Black Swan — Part 2
Trading Bitcoin in Fear, Greed and Recession
Take-aways
- Recessionary risk adds additional stress to low-profitability Bitcoin Miners in 2020
- If the percentage of Bitcoin Miners that are zombies is similar to the that of US listed companies, Hash Rates and Bitcoin’s fair value could fall an additional ~20% during a recession
- The “Amygdala Overdrive Relationship” suggests a high correlation of Bitcoin to equities in times of extreme fear and greed
- Early stages of a recession would likely see Bitcoin fall with global markets, later stages may see a Crisis Adoption event
- $100,000+ Bitcoin target within 5 years
- 2020 lower target: $6,400 Bitcoin at Christmas
Trading Bitcoin in Fear, Greed and Recession
This week has seen a significant Bitcoin retracement, preceding Monday’s biggest daily collapse in the stock market since 2008.
As outlined in Part I, we are witnessing extreme fear in global markets.
The Coronavirus has increased the probability of triggering a recession to a tinderbox economy and is sending amygdalas into overdrive globally.
While Bitcoin is mostly uncorrelated with other markets, it is still traded by emotional humans.
And when in fear, humans abandon “risky” assets.
Halvening + Recession = Big Miner Stress
In Part I we noted that 18% of US companies were found to be “zombies” in 2018, surviving paycheck to paycheck with the help of their credit lines. But we don’t know how many leveraged Bitcoin Miners are operating paycheck to paycheck today.
The Bitcoin Halvening event is already a stressful period for miners as their revenue stream effectively halves, causing low profitability miners to go out of business. Add a recession to the equation and tightening credit lines may put a lot more “zombie” Bitcoin miners out of business in a Credit Crunch type event.
If we estimate the number of Zombie Miners to be roughly the same as US listed companies, we should not be surprised to see a recession event result in an additional ~20% of Bitcoin Miners going out of Business (give or take a good margin of error here).
This base case estimate for a Bitcoin Miner Credit Crunch would result in a circa -20% drop in Hash Rates and therefore a -20% drop in Bitcoin’s fair Value (Bitcoin’s Energy Value).
In December 2019, the non-recessionary forecast for mid-2020 was a worst case Bitcoin Electrical Cost (the historic price floor) of $8,000. However, a recession adds a Bitcoin Miner Credit Crunch risk to the equation, the estimated worst case is now adjusted accordingly to $6,400.
Without doing a detailed study of Bitcoin miner financials, it is impossible to know how exactly how many are zombie miners there are and what the true risk is here. This estimate should be considered indicative only. The actual drop in Hash Rates and Bitcoin’s valuation due to a Bitcoin Miner Credit Crunch could be considerably higher or lower. We have never seen Bitcoin during a recession, and if it happens, it will be a learning for all.
But isn’t Bitcoin a Store of Value?
Like it or not, 99% of the world still sees Bitcoin as “risky” and public perception matters.
The current Coronavirus panic has ignited risk-off actions in your local supermarket, stock market and crypto market.
The Bitcoin “Store of Value” / “Digital Gold” argument will not be valid until the broader population sees Bitcoin as a better Store of Value than traditional assets. That is certainly not the case yet. Broader trust in Bitcoin in tumultuous times requires greater adoption or greater belief in Bitcoin’s monetary policy.
How might widespread adoption / belief be achieved?
- With time. Bitcoin has been growing in adoption steadily over the years, and every halving boosts public awareness to Bitcoin’s sound monetary policy. There is no reason to expect this to change with the passage of time and as the technology infrastructure surrounding Bitcoin improves.
- In peak crisis disillusion. When broader populations are in disbelief of their current financial systems and lose faith in legacy banking, we may witness fast-tracked Bitcoin adoption event due to its low inflation sound monetary policy.
“Crisis Adoption” will likely require global financial markets to be in a much worse position than they are today. A greater destruction of wealth is required to create disillusion and “break the trust” of the people in the current financial system, much like the 2008 crash did before Bitcoin existed.
If correct, the early stages of a recession will see Bitcoin suffer, and peak recessionary disillusion may offer some of the best risk-reward opportunities in Bitcoin’s history.
Bitcoin is not a Store of Value until the people see it as a store of value.
Bitcoin’s Amygdala Overdrive Relationship
In 2020 we have seen just about every case made for potential Bitcoin correlations to traditional assets. With the US-Iran tensions, it was argued Bitcoin was correlated with gold. With the Coronavirus it argued Bitcoin is correlated with Stocks.
But what is correct?
To date, neither Gold nor Stocks have shown sustained correlation with Bitcoin.
However, as noted by Fundstrat’s Tom Lee, Bitcoin’s best years have coincided with years of strong equity performance:
“Bitcoin does best when the S&P is up more than 15%”
This suggests that when the market is “risk-on”, investors seek returns from both stocks and Bitcoin.
Recently, we have also seen Bitcoin correct in near lockstep with the equities markets during a period of extreme Coronavirus driven panic.
This brings us to the following “Amygdala Overdrive Relationship”:
Bitcoin’s correlation to traditional markets today only exists at the extremities in fear and greed. Precisely at the times when primal human emotions take over.
That is:
- When markets are in Extreme Greed: investors are attracted to risky assets and Bitcoin performance correlates with equities
- When markets are in Extreme Fear: investors dump risky assets and Bitcoin performance correlates with equities
A comparison of Bitcoin’s price over the last 3 years against extremes in the CNN Fear and Greed Index demonstrates a case for this hypothesis. Note that the periods highlighted also have similar corresponding rallies and corrections in the S&P500.
Strong Bitcoin Fundamentals
Outside of the broader macroeconomic environment, all Bitcoin specific fundamentals currently look fantastic:
- Bitcoin’s Energy Value, a measure for its fair value, is currently 50% above Bitcoin’s price and increasing. Miners are currently committing to the network at the highest rate in Bitcoin’s history.
- Bitcoin is currently trading at its Production Cost suggesting a good value opportunity
- Bitcoin’s Supply growth rate is set to halve on 11 May, making it on par with Gold as the lowest inflationary assets known to man.
- Bitcoin currently has the highest level of global government support in its history. Germany, South Korea and India recently legalized trading, thereby effectively adding an additional 20% of world’s population to Bitcoin’s addressable market.
It is hard to find a negative when looking at pure Bitcoin fundamentals today. All metrics scream undervaluation.
What does this all mean for Bitcoin?
Long-term (12 — 24 months+)
Bitcoin’s outlook remains excellent. Extremely strong fundamentals and a potential recessionary “Crisis Adoption” event should be good for Bitcoin.
- Current target: $100K+ within 5 years
Medium-Term (mid — late 2020)
The halvening will double Bitcoin’s Production Cost (currently $7900).
But we now have the real risk of recession. If the Amygdala Overdrive Relationship holds, Bitcoin will draw down with equity markets during the early stages of a recession, until a potential “Crisis Adoption” event is triggered. A recession also adds the possibility of a Miner Credit Crunch and wipe out of Zombie Miners.
Should Coronavirus fear and recessionary risk subside between now and mid-late 2020, the original December 2019 forecast comes back into play.
- Current target (No-Recession): $8,000 — $17,800
- Current target (Recession): $6,400 — $17,800
Conclusion
The Coronavirus-triggered recession risk has added an unknown to the equation. We have never seen Bitcoin in an recessionary environment.
Bitcoin shows evidence of correlation to equities markets in cases of extremities in fear and greed, suggesting the “Amygdala Overdrive Relationship” could initially pull Bitcoin down in a recession. The CNN Fear and Greed Index has been identified as one way of tracking this.
In the medium-term, we can expect more volatility than would otherwise have been the case without this heightened macroeconomic risk. In times of extreme fear and greed, look to the stock market as an indicator for Bitcoin.
In the Long-term, the picture remains the same — excellent. In fact, the long-term Bitcoin value proposition may be stronger now due to the increased chance of recession, which could result in a Crisis Adoption event.
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CAPRIOLE INVESTMENTS
Quantitative Asset Management
www.Capriole.com
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