“Bitcoin diversification potential will strike back when the coronavirus crisis will diminish”
Interview with Yves Longchamp, Head Research at SEBA Bank
Bitcoin has gained a reputation as the digital gold. Then, with corona virus spreading all over the world, its value decreased by 50 percent within days. Why did that happen?
When such a price action takes place, all asset classes are hit badly, independent of their characteristics. The downside correlation increases. These movements are similar to those observed in the wake of the Lehman moment in 2008. But there might be an additional reason. When comparing the 30 percent decline in equities with the more than 50 percent decline in Bitcoin, it is important to remember that traditional assets were supported by massive injections of liquidity, increase in the quantitative easing program, lowering of interest rates, and stock market circuit breakers, to name a few. Such instruments do not exist for cryptocurrencies. What would have happened if they had not been used for traditional assets?
Central banks cut interest rates and inject liquidity in the markets. What does this mean for digital assets?
In such a troubled period, in which currency would an investor keep their savings safe? Outside money is the answer. It is a form of money that is not liable to anyone within the economic system. Throughout history, precious metals such as gold and silver have played the role of outside money, as they have been accepted internationally as a means of payments. It’s important to note that outside money is the currency of choice used to settle a transaction where there is no trust between the two parties. This was the case thousands of years ago in long distance trading, when merchants from different countries exchanged goods for gold. This is still the case today during wars, when countries pay for imports in gold as their national currency is not accepted across the border. Cryptocurrencies such as Bitcoin, Litecoin etc. are a new form of outside money, as they have many similarities with gold and silver.
Then you remain confident that cryptocurrencies will emerge stronger from the crisis?
There is no doubt that we will win the battle against the coronavirus. However, this battle will come at a cost. Public debt and central bank balance sheets will continue to increase, limiting their room of action going forward. The international monetary system may well come under pressure if confidence in these institutions wanes. Outside money is an asset class that protects against this type of risk. Some cryptocurrencies such as Bitcoin are new forms of outside money. We are therefore confident that the value proposition of cryptocurrencies will remain intact.
The price of Bitcoin fell in parallel with the stock markets. Do you still believe that cryptocurrencies can help diversify a portfolio after all?
Yes. The decline in prices has been general and observed over all assets. When massive sell off takes place, a flight to liquidity takes place, meaning that investors sell all what they can, without many differentiation between assets. In other words, what happened to bitcoin is not so different that for traditional assets, except for the magnitude of the fall as we mentioned before. Crypto-currencies are fundamentally different from other assets and we think that this is a strong basis for diversification. Their “business models” are different from bonds, equities and currencies. In our opinion, bitcoin diversification potential will strike back when the coronavirus crisis will diminish in intensity.
Can the very high volatility of Bitcoin be mitigated by a basket of crypto currencies?
A basket of cryptocurrencies definitely reduces the volatility but the overall volatile nature of the asset class remains because cryptocurrencies have a high correlation among each other. But volatility is a dynamic concept — besides the selection within a basket, it is greatly influenced by the allocation mechanism. For this purpose we have developed a proprietary method that specifically addresses this aspect. It mainly focuses on risk-adjusted performance but it could also be used to optimize the risk exposure for the overall asset class. Recent price moves have shown that the concept works, also in this exceptional and very extreme market situation.
Yves Longchamp is Head of Research at SEBA Bank. His professional experience has taken him from the Swiss National Bank to the world of crypto currencies, through major banks and asset management. Market finance and macroeconomics are the research topics that mark out his career. Before joining SEBA, Yves worked at Ethenea and for more than 15 years at Pictet & Cie, UBS and the Swiss National Bank.