Bitcoin and the Tale of Digital Gold. Why (not) have it in the portfolio


This year is shaping up to be better and better for Bitcoin in a number of ways. Since the beginning of January, the cryptocurrency has gained 100 percent, while the broad American stock index S&P 500 has increased by ten percent. What is perhaps even more important than the current price: during the last month of correlation, therefore, the apparent correlation between the price of the cryptocurrency and US stocks has practically ceased to exist. In recent weeks, gold has even behaved as it has never done in the last five years – that is, in direct contrast. If gold goes down, bitcoin goes up, and vice versa.

Cryptocurrency behaves like an investment by itself, which revives the idea that it should not be missing from any investment portfolio in the current turbulent times. Big companies would also like to make money from similar considerations. For example, the world’s largest asset manager BlackRock. He wants to launch an exchange-traded fund (ETF) in the United States, the value of which would depend on the price of bitcoins in the digital wallet of a partner company. The Bitcoin ETF is still awaiting approval from the regulator, but the sentiment in the crypto market seems to be that approval is virtually inevitable. This is also the reason why the price of bitcoin strengthened by about 30 percent in the month of October alone.

This year’s sharp recovery of bitcoin, after it fell to 16 thousand dollars last year, is also helped by the head of BlackRock, Larry Fink, with his words of praise towards the cryptocurrency. “People can take Bitcoin as an alternative to investing in gold as insurance against inflation and deep problems of one country or against the devaluation of a specific currency. Bitcoin is an international asset,” Fink recently told Fox Business.

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A skeptic would add that the current events surrounding the cryptocurrency exchange rate are primarily reminiscent of surfing on a wave of optimism. Cryptocurrency fans are speculating that an ETF will be approved soon. The demand is driving the price of Bitcoin higher in anticipation that the eventual approval of the ETF will start an even bigger wave of interest in Bitcoin. Both are possible, but certainly not certain. Anyone who would like to draw far-reaching conclusions from current events about how the development of stock indexes, gold prices and cryptocurrencies are related to each other must look at longer-term trends. These show infographics of the e15 server, available for registration (free).

The Bitcoin exchange rate emerges from them alternately as a completely independent element on the financial markets and as a mere technological stock. For example, last year the correlation between the development of the price of Bitcoin and the Nasdaq index of technology stocks reached the highest level for the entire monitored period. This was linked to concerns about the effects of rising rates in the United States. As expected, this had a negative impact mainly on growth stocks, or rather stimulated another rush from riskier types of investments, where cryptocurrencies cannot be excluded due to volatility.

On the other hand, bitcoin is paying for the most profitable investment of the last decade and surpassed its long-term price records less than a year after it itself underwent a rather drastic “tightening of monetary policy” in 2020 – the May halving meant a halving of the daily newly mined digital coins. At a time when central banks were flooding economies with cheap money during the pandemic, Bitcoin went the way of increasingly hard “currency”, gaining attention not only among fans.

Bitcoin Versus Stocks: The Role in the Portfolio

Reflections on the importance of bitcoin in an investment portfolio were greatly stimulated by American billionaire and hedge fund manager Paul Tudor Jones the year before.

“The idea that higher inflation is a temporary phenomenon runs counter to how I see the world,” Jones told CNBC. The only certainty, according to him, is that he wants to spread his investments in the ratio of five percent gold, five percent bitcoin, five percent cash and five percent commodities. Jones sees the digital currency primarily as a means of portfolio diversification, thanks to which he will better protect the value of his assets in the long term.

Several years of quarterly statistics showing the degree of correlation between the value of Bitcoin and other types of investments prove Jones right. A separate topic then is why not deposit more than five percent of your wealth in bitcoin. Even in this case, the answer can be found in infographics.

But in order. One of the proven advantages of Bitcoin is that its value usually moves at a different rhythm than that of stocks or gold. In part, this is a consequence of the still relative immaturity of bitcoins – for example, their market value is still far from that of gold, and it is easier for big players to move the rate in one direction or the other.

Another factor is the extraordinary liquidity of cryptocurrencies – they are traded globally 24 hours a day, seven days a week. Unlike stock markets, crypto exchanges do not know breaks. Furthermore, no corporation or state can “shut down” the Bitcoin network.

In the monitored period between 2017 and 2022, bitcoin appears to be an investment on its own, the price of which is related to developments in other markets rather weakly, at best moderately strongly. This is true even if the extraordinary upward price swings of Bitcoin are omitted – typically in December 2017 and April 2021, when the price of the cryptocurrency increased exponentially. But slightly warning is that the degree of correlation between Bitcoin and US indices increased between the last quarter of 2020 and 2021. The rise continued in 2022.

Different measures of correlation

Correlation expresses the strength of the relationship between two variables. It takes on values ​​from 0 to 1, where a value of 1 means absolute agreement between the variables and 0 the absolute absence of any relationship.

  • 0 to 0.3 – very weak to no relationship between variables
  • 0.3 to 0.7 – moderately strong relationship
  • 0.7 and above – very strong relationship

The same applies in the opposite guard with a minus sign, but it is an inverse proportion.

Thus, correlations of −0.8 and 0.8 are equally strong.

However, investors should not take bitcoin, much less other cryptocurrencies, as a guaranteed insurance against massive swings in financial markets.

Cryptocurrencies, Gold and Safe Harbor. How big a shock (can’t) withstand

The reason was the “corona massacre” in the markets in March 2020, when due to the spillover of the pandemic to the USA and the fear of investors, bitcoin wrote off fifty percent in two days.

There have been a number of views that bitcoin has failed miserably in its role as a store of value – despite its subsequent recovery. In the period of the covid shock, however, the sharp fall hit not only digital currencies, but also stocks and gold.

The independence of the price development of the dominant cryptocurrency has clearly hit its limit. Even the Bitcoin exchange rate could not withstand the effects of such an extraordinary event as the closure of a significant part of the world economy.

“I consider Bitcoin as one of the investment alternatives. Sort of like an insurance policy where you deposit a percentage or two of your net worth. That’s for catastrophic scenarios. Bitcoin has another advantage that the owner can replicate his bitcoins anywhere in the world just by remembering the password (seed) and having access to his money. It really is like insurance for me. And at the same time protection against inflation and a good investment,” John Vanhara, a Czech entrepreneur in the USA, described his perception of cryptocurrency as a “safe haven”.

However, in the case of further exponential appreciation of digital currencies, even a relatively small investment would mean interesting returns. Multiple profits are no exception with Bitcoin. The weight of the cryptocurrency in the portfolio can thus inflate very quickly. Then they would prove to be acute considerations for further diversification.

Bitcoin vs Altcoins

Those who want to stick to cryptocurrencies can’t help themselves, even though there are quite significant technological differences between them.

While Bitcoin is considered by fans to be a virtual currency or “the hardest currency of all time” due to the capping of the number of coins at 21 million, as the economist Saifedean Ammous likes to repeat, the Ethereum blockchain (with the virtual currency ether or ethereum) works more like a supercomputer. A number of applications already work on it, which allows, for example, to obtain a loan or collect interest without the need to use the services of an intermediary, typically a bank.

If there is a massive digitization and automation of services in the financial sector in the near future, according to Ethereum’s supporters, it will be largely due to its technological capabilities. However, such a difference is not visible on the mutual price dependence curves. Bitcoin and the cryptocurrency ethereum are highly correlated.

Holders of the most widespread cryptocurrency may therefore find it useful to diversify their portfolio not only through shares, but also through gold.

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The article is in Czech

Tags: Bitcoin Tale Digital Gold portfolio


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