What Is “Store of Value” Risk?
Lesson M: Betting on Stability in a Currency
“Store of value” is the feature of a currency or commodity to act as a stable, or non-volatile, measure of price. An ideal store of value would act as the center by which the prices of all other goods and services would be determined. This does not necessarily mean that prices would be permanently static. Prices could rise (inflation) or fall (deflation), but respectively do so in relation to the store of value.
For example, we often think of the US dollar as a store of value. It tends to be less volatile than other world currencies due to economic and political reasons. The US not only has a large economy that can withstand certain shocks, but historically the US also tends to be stable politically. There is also the fact that since the Bretton Woods Agreement of 1944, the US dollar became the world reserve currency. What is a world reservice currency?
You can think of a world reserve currency as the “go-to” currency that can be used internationally for transactions because it is freely convertible, is extremely liquid, and is controlled by a central banking system independent of the executive branch of the government. (Central banks use monetary policies; executive branches use fiscal or tax policies.)
The US dollar meets these requirements and therefore equates to little risk when people hold them. So using the US dollar as a store of value would mean exchanging one form of value for US dollars. Instead of holding value in tech stocks, I might want to “go to cash” and liquidate my stocks for US dollars. Or, when the money supply becomes constrained (e.g. when fiscal policies initiate quantitative tightening), holding cash is a good bet.
A general indicator of the value of the US dollar as a store of value is the US dollar index which measures the value of the US dollar against a basket of other currencies:
Historically, the US dollar index experienced its lowest on March 16, 2008 with a value of 70.698 and its highest in February 1985 with a value of 164.720.
How Is Store of Value Subject to Risk?
There are two ways to think about risk in relation to stores of value:
- how its value can be affected by significant events; and
- how its value changes in relation to other commodities and currencies.
Macroeconomic changes can affect the way a world reserve currency will move up or down in value. For example, when a recession occurs, the US dollar will fall. You would expect the other currencies with which the US dollar is compared to fall as well; however, because the US dollar acts as the currency for international transactions, its value is more systematically vulnerable. In short, the US dollar (as a store of value) is stable when the macroeconomy is flat to doing well.
When the macroeconomy is doing poorly, the US dollar drops in relation to other commodities and currencies. In particular, this is true for gold, which often acts as the inverse investment when the macroeconomy enters a bear market or a recession.
Are Stablecoins a Store of Value?
Theoretically, stablecoins are supposed to act as stores of value for the cryptocurrency markets. Most stablecoins try to do so by:
- being pegged to the US dollar; and
- backing value with fiat currencies and other assets
However, there are a lot of caveats with stablecoin risks which concern counterparty risk and conceptual design risk. The fall of US Terra in May 2022 involved both — it was not fully backed and its design in relation to Anchor Protocol created further liquidity problems.
What Does This All Mean?
Risk mitigation for store of value is really for investment purposes. Remember this: Are you better off keeping your value in the currency acting as a store of value? Or, are you better off investing that value elsewhere?
This dilemma will ask you to consider whether the alternative to the store of value is increasing in value, and at what rate? and with what risk?
Sometimes it’s not only safer to “go to cash”, but you can even gain from it if your purchasing power increases; or if you take into account a “counter factual” situation. If you not gone to cash, you would have invested the money in an asset that has since dropped in value significantly. So in that sense, you have gained.
Store of value risk does not really matter too much to everyday use of currencies. This is because we have to use such currencies to address everyday needs. When the macroeconomy is down (and interest rates are up), we merely suffer with regard to a loss in purchasing power and an increase in the cost of borrowing.
Note well, that stablecoins tend to be used mostly for investment purposes — they act as a common form of liquidity for exchange of crypto assets across platforms and for converting cryptocurrency back into fiat.
This article is a part of the Crypto Industry Essentials educational program presented by 1.2 Labs (formerly The Art of the Bubble).
Though this article is credited to me, it contains some written material by Sebastian Purcell, PhD from his 1.2 Labs education series on cryptocurrencies.
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