Bitcoin as a Safe Haven: Breaking Down Correlations and Adding Valuable Insights
Analyzing all of Bitcoin’s relevant correlations and theses in a year of unprecedented economic chaos reveals why it’s becoming a portfolio mainstay for corporate treasuries.
2020’s drawing to a close and Bitcoin’s currently up 167% on the year, with no signs of stopping its growth anytime soon. Since our last Bitcoin-centric post was in October, it’s time for a November Bitcoin update.
So, to kick things off, what’s happened since October 30th?
In short, a lot. To help us sum up Bitcoin’s progress thus far as well as the road ahead, we’ve again brought in the opinions of a few experts.
As the storm continues, is Bitcoin the ideal life raft?
First and foremost, let’s kick things off by revising the key ideas that we introduced last time. Chief amongst those were that continued institutional adoption would increase overall positive sentiment and lead to an all-time high, and that the value proposition that’s likely responsible for the bulk of this bull market is that Bitcoin has true digital scarcity.
Bitcoin as Digital Gold
Since Bitcoin’s launch back in 2009, it’s been termed “digital gold” due to its invention of digital scarcity and the resultant idea that over time, it should provide a better overall return on investment. To understand how that narrative’s been playing out in practice, it’s important to analyze the correlation between bitcoin and gold using the most current data. Looking at the chart of the pairing below from Skew Analytics, one key insight comes to light.
As of now, these leading hedges are negatively correlated, sitting around the -8% range. What this means is that around 8% of the time, they move in opposite directions, i.e., when one goes up, the other goes down. If this disconnect continues to grow, both gold and “digital gold” may reach the point where they exit into the post-COVID world, still significantly inversely correlated. Still, the above only represents the pair’s relationship during 2020. What about the years prior to the pandemic?
Since 2018, bitcoin and gold have averaged a 12-month correlation of 6.3%, which indicates that even with Bitcoin breaking away this year, the two assets still tend to move in tandem, albeit in a reduced sense from earlier in their history. For now, this is a good thing since as Lyn Alden and other point out, gold is “partially uncorrelated” with essentially everything. For Bitcoin to prove it can work as a better gold, i.e., “digital gold”, it will have to continue its’ currently explosive growth in a world where interest rates and bond yields have stabilized and markets are largely back to normal (whatever the new normal is). In the event that it ends up doing so while breaking away from stocks and bonds in the same way it has from gold, then crypto’s leading asset would have arguably cemented itself as a viable safe haven. As you watch its progress in this respect, keep in mind that Bitcoin’s confirmation that it works as “digital gold,” doesn’t have to mean the elimination of traditional gold. In fact, it’s quite likely that both will continue to persist for years to come, which is something we’ll discuss in future analyses.
What is Bitcoin’s correlation with stocks (via the S&P500)?
All in all, the current Bitcoin-led bull market that began in October has fueled a considerable disconnect between bitcoin and the stock market, as represented by the S&P500 index (SPX).
As of now, Bitcoin and the SPX are sitting at about a -33% correlation. Generally, this major movement towards a negative correlation appears to have been fueled by the spike in adoption that Square, Paypal, MicroStrategy and others started. Before concluding that this points to Bitcoin being an effective hedge against stocks, however, consider this.
In 2020, the correlation between the SPX and Bitcoin has presented itself as a wave, with considerable positive spikes between Bitcoin and stocks each quarter. Consequently, only the end of the year will shed more light on whether such a trend will continue or dissolve in favor of a greater disconnect. For now, however, Bitcoin’s weak negative correlation with the S&P500 serves as a roadblock towards its’ progress to being a reliable safe haven.
What about Bitcoin and Bonds(US 10-Year Treasury Bills)?
At this point, we’ve analyzed Bitcoin’s correlation with gold and stocks, including how its’ developed during this particularly chaotic year. Through bringing bonds into the picture, a particularly useful insight related to Bitcoin’s march towards being a safe haven is illuminated.
Judging by the chart above, bond yields have been falling since the end of 2018, despite a brief spike this year. Before considering what this indicates, ask yourself: what is yield? On a fundamental level, it’s really nothing more than the return on investment that’s realized by bond holders.
Now consider the year we’ve had. As COVID-19’s effect on the world has worsened, interest rates and bond yields have plummeted and that’s not just in the United States. EU bonds, as well, have plummeted this year with most member countries hitting yields of below zero for 10-year bonds. This has engendered massive government-led bond purchases and the issuance of a new “social bond” which aims to keep EU citizens working through government-funded growth to the tune of 30 billion Euros. Though it isn’t part of the EU, Norway, where we are headquartered, hasn’t escaped the turmoil with regards to diminishing bond-yields. From an average yield of 1.49% on 10-year bonds in 2019, Norwegians are now experiencing a yield of only 0.854%(as of December 7th).
With these numbers as well as the overall global economic downturn in mind, it is logical to conclude that everyone’s looking for new avenues for better, reliable growth.
With Bitcoin sitting at a 167% return including volatility since January and an 80% return since the 1st of October, it may be expected that some of the shift in sentiment (aggregated market perception) of Bitcoin is due to a loss of confidence in bonds. Still, for Bitcoin to be a reliable competitor over the long-term, it will have to sustain a significant ROI, together with a consistent decrease in yearly volatility. While the former has historically been achieved, the latter has been the sticking point for Bitcoin’s critics.
Presently, Bitcoin’s standard deviation of daily returns is close to 2.5. What that indicates is that its’ current estimate of monthly volatility is 3.42%. The CBOE’s TYVIX Index, which measures the expected volatility of US 10-Year Treasury Bills, is currently at $4.71 a share, having risen from $4.11 a share at the start of the year. Generally, each jump in any VIX index is used as what is called a “leading indicator” to show where investor sentiment should be leaning going forward. The reason it’s considered to be a powerful indicator of bond market movement is that it measures the flow of options on 10-Year US Bonds. If you know that option flow, in general, is used to measure volatility, then you understand the utility of the TYVIX as well. When, for example, calls on an asset or index greatly outpace puts, then sentiment is said to be pointing to a bear market on the horizon. In the TYVIX’s case, that idea has been simplified to the point that when shares in the index go up, the same is said to be true. As with any indicator, the TYVIX isn’t perfect and works better with a suite of other indicators alongside it. Still, in understanding the fact that bond market volatility is slightly rising while Bitcoin’s volatility is falling, you’ve got another valuable trend to watch in connection with its correlations.
If you compare the TYVIX’s volatility to that of the VIX, which serves as the same sort of forward-looking indicator for the stock market(using the S&P500), then it becomes clear why bonds are likely to persist as a fixed income asset. Compared to both Bitcoin’s long-term volatility, which has averaged 5% or more, and that of the VIX, which is at roughly 10% since its inception, that of the TYVIX, which is at 0.87% over 5-years is negligible.
So, is Bitcoin a safe haven?
With the data above, it’s clear that Bitcoin has a long-way to go before it’s a fully-reliable safe haven. Still, judging by its progress and the current adoption cycle, which continues to be led by institutions, it’s working its way there. Through reinforcing the major drivers of Bitcoin’s growth this year, this potential is relatively easy to see.
What’s fueling Bitcoin’s growth in 2020?
“The more things change, the more they remain the same.”-Jean-Baptiste Alphonse Karr.
While Bitcoin’s correlations don’t quite support it being a universal safe haven with hard data, its fundamentals are still as sound as they’ve always been. It’s still the world’s first decentralized, peer-to-peer currency that works, its supply is still hard-capped at 21 million bitcoins and it will still undergo “halvings” of its block reward every four years until no more new bitcoins are issued. Moreover, it’s not just these fundamentals that have caused the influx of new bitcoiners that we’re still experiencing.
In an overarching sense, Bitcoin’s rise is being driven by network effects.
If you think of bitcoin adoption as a cycle driven by institutions first, then retail investors, which causes even more institutions to take the plunge, then you’ve got the gist of just how powerful its rise could become on a longer time-horizon. Consider October 7th. By the end of that day, Bitcoin’s price was just over $10,600. One day later, Jack Dorsey’s Square Inc. announced that it had invested $50 million in capital in Bitcoin to bolster its treasury reserves. While the investment amounted to only 1% of their entire reserves at the time, it was the message they attached to it that helped to kick the first snowball down the hill, which eventually turned into an avalanche of institutional involvement. Two days later, Square’s CEO, Jack Dorsey, did an interview in which he shared a white paper that he termed as a guide for any institutions who are interested in investing in Bitcoin but haven’t been able to get their heads around it just yet. It’s that white paper that could reasonably be said to have served as a major headwind for Bitcoin.
Why Square’s Bitcoin investment whitepaper matters
“Given the rapid evolution of cryptocurrency and unprecedented uncertainty from a macroeconomic and currency regime perspective, we believe now is the right time for us to expand our largely USD-denominated balance sheet and make a meaningful investment in bitcoin.” This quote from Square, together with Raoul Pal’s thesis on “Bitcoin as a Life Raft” would seem to point to the logic behind the substantial shift in institutional sentiment towards Bitcoin.
Essentially, in a time of heightened global uncertainty, companies are looking to establish better reserves. A reserve is an asset that companies hold to make sure that they can meet their obligations and even stay profitable to best of their ability during emergencies and even times of prolonged crises. Square led the institutional shift into Bitcoin this October, followed by MicroStrategy, who has now become the loudest Bitcoin-bull who isn’t a crypto-centric individual or company. In total, today, there are 15 companies who are publicly buying Bitcoin directly to add to their treasury reserves and others doing so through more indirect investment vehicles like Grayscale’s Bitcoin Trust.
In a nutshell, if you’re looking for the why behind this shift, it’s reasonable to argue for businesses wising up to the value of provable scarcity and growth that occurs even during times of widespread crisis. This does not mean, however, that Bitcoin can replace stocks, bonds, gold, or others as portfolio mainstays, at least not yet. Even in the case of MicroStrategy, which has publicly stated that it is looking to “eschew inflation-prone cash for Bitcoin,” their Bitcoin holdings only amount to a fraction of their total reserves. When asked if he aligns with this idea that Bitcoin is basically a life raft away from the traditional financial system, Anthony Pompliano responded:
“Yes, i think it is structurally created in a way that provides protection from fiat currencies and long term inflation.”
Since Bitcoin is structured to be a truly decentralized, peer-to-peer currency and asset with a provably limited supply and an issuance that decreases over time, it would seem that the argument for it as a reserve is clear. While cash and other traditional reserve assets like gold are tied to inflation, Bitcoin isn’t.
Whether this rationale will help firms like MicroStrategy realize their vision of being truly Bitcoin dependent down the road, only time will tell. Whatever the case, in terms of institutional reserve portfolios, it appears Bitcoin is here to stay. The question that remains is whether its allocation will grow, even when the non-crypto economy starts to finally significantly stabilize.
Looking Ahead: Perhaps a safe haven doesn’t need to be universal
So where does this leave us?
Digging into correlations is only the tip of the iceberg. Still, certain factors are clear after the above is taken into consideration. For example, in a big picture sense, Bitcoin’s growth is being driven by institutions wising up to its potential value as a reserve asset and both institutions and retail investors beginning to see it as a better source of long-term growth than most other assets. When asked about Bitcoin’s value going forward, Andy Pickering, a Senior Editor at Brave New Coin, said:
“As I write this, the Bitcoin price is holding steady at $19,000. After briefly touching the all time high at the beginning of December, Bitcoin looks to be consolidating before an eventual push above $20,000. There’s every chance Bitcoin experiences a major correction first, however, it appears that any dip is being bought aggressively for now. There is some truth to the supply crisis narrative. It’s a simple combination of less supply following the May halving, and the accelerated buying by big entities such as Square, PayPal, and Grayscale. Many have already pointed out that Bitcoin’s three-month surge to the current price has been mostly ignored by the mainstream media and the general public. It’s still quiet out there. However, interest is building and new buyers are quietly taking positions. Our website traffic at Brave New Coin has doubled in the last two weeks. The majority of those new visits are reading articles related to how to buy or how to mine Bitcoin and other crypto assets. This is the same trend we saw in late 2017 — about two months before BTC hit its current all high time. Most will be glad to put 2020 behind us, and Bitcoiners can look forward to fireworks in 2021. Is Bitcoin the best saving technology ever invented? It is certainly performing that way.”
As Pickering concludes, we’re not at the point where Bitcoin has fully realized its potential along the lines of either of its’ major value propositions yet. As he states, “interest is building” and overall, it’s early yet. Therefore, as the year comes to a close and we gradually begin to enter a post-COVID world, it’s never been more important to develop as balanced a picture of Bitcoin’s developing value as possible. With that in mind, in our next post, we’ll attempt to bridge novel metrics, beyond mere correlations to see if the case for Bitcoin as a macro-hedge and a reliable treasury reserve has further quantitative foundations. While doing so, we’ll also analyze the opinions of other experts on the subject, including critics, to attempt to bring you as balanced of a picture as possible in the end. For now, if there’s one key takeaway from all of this, it’s that as we’ve previously noted, Bitcoin appears to be making its’ way effective hedge against “macro-uncertainty,” which is synonymous with becoming a fairly universal safe haven.
As you analyze this case further for yourself, keep in mind that it’s also not enough to simply consider Bitcoin as a way out from everything else. Instead, it’s better to use real-time data to see how it performs against other, more traditional asset classes as described above, then make conclusions on the subject. Putting real-time data together with a thesis like “Bitcoin is a way out” or a “life raft,” allows you to work with as balanced of a strategy as possible and truly begin to sift the signals related to Bitcoin’s value from the noise. Ahead of our next post in this series that will serve as an end-of-year wrap-up, we’ll delve into what a Bitcoin supply-shock is, why it’s happening now, and how it could fuel an even greater Bitcoin bull-market down the road. Further down the line in January, we’ll also dig into how a greater currency devaluation could add even more fuel to Bitcoin’s long-term growth. It’s our hope that with all of these Bitcoin-centric posts, you’ll find it easy to differentiate between the considerable noise that the crypto markets generate and the true signals. Until next time, as always, remember that we’re here to help you. If you have any thoughts or questions about this post as well as others, reach out to us any time here, on Twitter, or our website!
Special thanks to Anthony Pompliano and Andy Pickering for their time and contributions. Please follow both on Twitter through clicking their names and also consider following their podcasts, the Pomp Podcast and Crypto Conversation.
