Hedge or cyclical? Eternal debate on Bitcoin’s status sees a new twist

One of the most enduring stories about cryptocurrencies revolves around the definition of cryptocurrencies as an asset class. Is bitcoin (BTC) more of a digital currency or digital gold? Do its unique characteristics guarantee that it will be treated as something completely different from established categories of financial instruments? A recent report by strategists at JPMorgan Chase has reignited this debate.

The report’s findings contradict the idea that bitcoin is a safe asset, which has become a widespread misconception recently. The authors argue that the original cryptocurrency is actually not a very good hedge in a highly stressed market, and that with the expansion of private ownership it has become more of a cyclical asset that rises and falls with the stock market.

It is advisable to discuss the arguments of JPMorgan’s analysts with financial commentators to assess their strength, and to consider what recent developments in the crypto markets might tell the general public about the nature of digital assets as a class.

Other hedge type

A good hedge must be able to withstand the forces that can drive down the value of most other assets in an investor’s portfolio. The point is that JPMorgan strategists, who oppose the hedging of BTC, seem to rely heavily on observations from last year, when crypto and traditional markets fell in March as a result of the panic caused by COVID-19, and began to rebound to their record highs shortly thereafter.

The report’s reasoning is also full of assumptions. It contains a very specific definition of the covered asset, taking into account only a limited number of risks against which it protects. This also implies that cryptocurrencies behave more or less uniformly under different market conditions.

Brock Pierce, president of the Bitcoin Foundation, noted in an interview with Cointelegraph that bitcoin’s behavior as a mature asset does not necessarily follow a rigid pattern in all situations: I agree with them to a certain extent that it is not a hedge because it has become what it can be. He added:

It has sometimes been an excellent protection against inflation in many countries of the world. Sometimes, when markets – stock markets and bond markets – are at a general risk of rising or falling, we find that bitcoin can go with the flow because it is the most liquid asset for many people.

Amber Gaddar, founder of decentralised capital market AllianceBlock, who previously held senior positions at JPMorgan, told Cointelegraph that bitcoin is a poor hedge against acute market stress as a pure hedge asset and for shorter maturities of a month or a quarter, compared to the US dollar, Swiss franc and Japanese yen. So it is in line with JPMorgan’s estimate: That’s because bitcoin doesn’t have a short base that encourages an appreciation of the dollar in the event of market shocks.

However, this does not mean that BTC cannot be used as an insurance policy against events such as a destabilizing rise in inflation or a political shock, Gaddar added. For them, bitcoin is better known as :

High volatility, high return, driven by its idiosyncratic characteristics, allowing diversification of the portfolio rather than being a pure hedging instrument in the portfolio.

Another point to note is that during the pandemic market crash in March 2020 due to black suan, almost all liquid assets were highly correlated in their simultaneous declines. So it doesn’t necessarily mean that bitcoin and stocks should have a similar relationship, for example between the S&P 500 and the price of BTC.

Seamus Donoghue, vice president of sales and business development at Metaco, a digital asset infrastructure provider, told Cointelegraph that after acute liquidity events such as the March 2020 stock market crash, asset correlation tends to approach 100% and all types of assets are sold to increase liquidity. He also questioned the fact that the report addresses only some risks and not others:

The authors seem to combine hedging acute liquidity events, which always involves turning all assets into cash, with hedging risks such as monetary and fiscal mismanagement. It is important to distinguish between the short-term effect of liquidity on assets and the fundamental characteristics and properties of hard assets, such as gold and bitcoin.

Constantin Richter, CEO and founder of Blockdaemon, told Cointelegraph that aside from the largely exogenous shock of the Spring 2020 pandemic, there has yet to be a truly hostile economic environment that has really tested crypto as a store of value against other assets. Richter is convinced that digital assets will outperform any competition after such a test.

Still not cyclic?

As for whether bitcoin will be like the discretionary stocks that do well when the global economy is booming, those who shared their thoughts with Cointelegraph were not convinced. Gaddar does not believe the introduction of retail business increases the ratio to cyclical assets. In fact, she thinks it works the other way around: Most retail investors prefer HODL (buy and hold) bitcoin. The same cannot be said for the new institutional and hedge funds that have recently plunged massively into bitcoin.

Gaddar also noted that the correlations identified by the report’s authors may simply be an artifact of the measurement tool they used. By applying Spearman’s correlation coefficient instead of the commonly used Pearson’s coefficient, Gaddar’s team could not find that crypto asset prices were significantly different from those of other asset classes.

Some have even called JPMorgan’s motives for the report’s conclusions on the launch of JPM Coin questionable. Louise Murray, vice president and head of sales for Railsbank’s banking platform, said:

Presumably this is ultimately where their interests lie. If we dismiss bitcoin as a cyclical asset, we forget the purpose of bitcoin, which is to provide an electronic payment system as an alternative to financial institutions and act as a trusted third party in financial transactions. However, it is these third parties that add extra fees to a traditional financial transaction that Bitcoin is trying to solve.

Distinctive features of cryptoAssets

After all, what is left of crypto’s properties as an asset class? Pierce believes that bitcoin’s status as a financial instrument has not changed much, as he noted: Over the past year, we have learned something about the nature of bitcoin as an asset: What it is, what it could be and how it could affect people’s portfolios and investment decisions is evolving at a rapid pace.

There are also unique features that can be identified with certainty. The main advantages of bitcoin are faster settlement and greater global exposure than any other traditional financial market asset. Ultimately, cryptocurrencies now have the potential to develop important properties – as a means of payment, not just as an investment vehicle. In the long term, this may lead them to move away from traditional financial assets.

In addition, Murray expects crypto to become more regulated and accessible, which will reduce market volatility. As younger generations invest their money differently, Murray expects new cyclical patterns to emerge in the future, perhaps with markets following crypto principles rather than the other way around.

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