Bitcoin Bros, Assemble

By: Steve Sosnick, Chief Strategist at Interactive Brokers

Amidst a world of breathless bros and skeptics, I remain agnostic about cryptocurrencies. As with any investment, I do my best to weigh the pros and cons in order to decide whether they are likely to appreciate or not. This year’s Bitcoin 2022 conference underway in Miami, and there are likely as few agnostics and non-believers as one would find at a religious confab. It is hard to imagine that the likes of Michael Saylor (of MSTR), Cathie Wood (of ARKK), or Peter Thiel (of PLTR) are speaking at that conference to express anything but rosy views. It, therefore, seems like an appropriate time to take an objective view about the prospects for the flagship cryptocurrency.

Let me get my opinions out of the way first. I have often commented that blockchain has the potential to be a significant technological development and that we are in the earliest stages of finding profitable applications for it. Bitcoin was the first expression of blockchain, yet the public’s focus on crypto over blockchain can be a distraction in much the same way that the early internet gold rush distracted from the ultimate benefits of the internet. The copious crypto advertising that we are all exposed to on a daily basis certainly adds to that distraction, especially since much of it is FOMO-based. The ads seem much more about playing to investor fears of missing out on the next big thing rather than explaining why cryptocurrencies may indeed be the next big thing.FOMO is not an objective investing strategy.

I have also been quite clear about asserting that bitcoin has more of the characteristics of a risk asset than those of a currency or a non-correlating hedge under all but extreme circumstances. This is not a negative – risk assets can be quite rewarding investments – but a means of classifying the framework under which bitcoin can be assessed. There are certainly benefits to owning bitcoin as a potential crisis hedge, something I discussed recently with a billionaire investor. If you live in a country that borrows to fund its debts in currencies other than its own, it can provide a hedge against potential devaluation, much like gold has done historically.  

We have discussed (seemingly ad infinitum) that the prospect of hawkish central banks raises the prospect for additional volatility among risk assets. This has certainly been the case among equity indices and fixed income. Yet the historical volatility of bitcoin has been declining. According to Bloomberg data, the 9-day historical volatility of bitcoin is 29.889 while the 7-day volatility of the Philadelphia Semiconductor Index (SOX) is 30.059. (Remember that bitcoin trades 7 days a week, so 7 trading days of an equity match 9 trading days of a cryptocurrency).On a longer-term basis, however, bitcoin has been much more volatile. The 365-day historical volatility of bitcoin is 61.267 while the 256-day historical volatility of SOX is 25.367 (remember the difference in trading days).

There are key factors that could explain the relative quiescence of bitcoin recently. The events in Ukraine may have inspired investors in Eastern Europe and beyond to add exposure to bitcoin as a crisis hedge. The significant purchase of over 4,000 coins by Microstrategy (MSTR) from February 15^th through April 4^th may have had a dampening effect to any declines during that timeframe. (Bear in mind that if Mr. Saylor talks his book at the conference)It is also possible that bitcoin may simply be less sensitive to changes in monetary policy than other financial assets. 

Yet I doubt that last point. It is quite possible that bitcoin investors are less sensitive to changes in short-term gyrations of other financial assets than investors in stocks and bonds because they tend to work in a somewhat isolated financial ecosystem. But over time, it seems implausible that cryptocurrencies can be immune from the effects of tighter money overall. It is important to keep in mind that bitcoin was first created in 2008. At that time, the global financial crisis (GFC) was climaxing and about to end amidst a then unprecedented amount of monetary and fiscal stimuli. Since then, with only brief exceptions, global monetary conditions have been expansionary. Bitcoin recently became mainstream amidst the post-Covid monetary and fiscal stimuli that dwarfed the response to the GFC. Ask yourself whether cryptocurrencies, NFTs, DeFi, and the like would have blossomed the way they did if the Fed and other central banks weren’t relentlessly adding money to the economy, if real interest rates weren’t negative, and if individuals weren’t receiving checks in the mail from the government. If you recognize that any of those were potentially contributing factors, then you have to be concerned that the inverse could be true as monetary conditions tighten.

As the chart below shows, bitcoin has been a solid performer since last year’s conference in early June, outpacing key US indices and gold. Yet as we noted recently about meme stocks, the latest movement may be being driven by those already with a vested interest rather than new investors. If that is the case, a conference that preaches to the converted may not prove to be much of a catalyst.

Normalized Performance of Bitcoin (white/blue bars), NASDAQ 100 Index (NDX, blue), S&P 500 Index (SPX, red), Gold (XAU, purple)

(Click on image to enlarge)

Source: Bloomberg