Main Takeaways
During periods of market turmoil, people often turn to trusted investments to protect their wealth. These are often called “safe-haven assets.”
Recently, cryptocurrencies such as bitcoin have increasingly been suggested as a new and innovative safe-haven asset to hedge against economic uncertainty and rampant inflation.
Given bitcoin’s properties and performance, its potential viability as a long-term store of value cannot be overlooked. Nevertheless, the digital-asset industry is still nascent, and we need more time to draw robust conclusions about crypto’s safe-haven capacity.
Uncertainty has defined the global economy lately, with consistent market instability, supply chain disruptions, and rising inflation resulting from a chain of pandemics and fierce regional conflicts. Since 2021, central banks around the world have been struggling with inflation, which surged in the wake of the COVID-19 pandemic. According to data from the International Monetary Fund, average inflation around the world hit 8.7% in 2022, more than two points above the 6.4% seen in 2008 during the Global Financial Crisis. While these rates have begun to soften in 2023, some experts are still bracing for the possibility of an imminent recession, as the global economic outlook continues to deteriorate in the face of geopolitical shocks.
In times of chaos and uncertainty like these, people often turn to trusted assets to protect the value of their assets and hedge against surging risks. These investments, known as “safe-haven assets,” are generally expected to maintain their value during periods when fiat money and equity stand at an increased risk of devaluation. In recent years, cryptocurrencies such as bitcoin have increasingly been suggested as safe-haven assets, offering innovative alternatives to traditional avenues. This article will examine the argument for cryptocurrencies, particularly BTC, being able to serve as safe-haven assets, diving deeper into macroeconomic dynamics, cryptocurrency mechanisms, and critics’ objections.
Safe-Haven Assets
Safe-haven assets are financial instruments that retain or increase in value during periods of market turbulence. These assets act as a form of insurance, offering stability or even potential profits when other investments falter. Perhaps the most well-known traditional examples include gold and government bonds. Throughout history, gold has proven itself to be a trusted store of value, with its value often rising during economic recessions. Likewise, government bonds, especially from stable governments like the U.S., are considered safe because they are backed by a guarantee of repayment from a credible issuer.
In the digital era, some cryptocurrencies have begun to position themselves as a potential safe-haven asset class. Digital assets such as bitcoin operate on a decentralized network, making them immune to government interference – an appealing factor during times of economic uncertainty. Despite periods of extreme volatility and spectacular price corrections, bitcoin’s overall trajectory has been upward for its entire history, sparking interest in it as a potential long-term store of value to hedge against inflation and market volatility. This is why BTC is sometimes referred to as “digital gold,” highlighting its shared characteristics with the historically most widely used safe-haven asset.
The Fiat System
The current global monetary system is primarily fiat-based, with currencies backed by trust in governments and central banks rather than gold or other commodities. In a fiat monetary system, central banks can combat economic uncertainty and inflation by adjusting policy instruments such as interest rates and reserve ratios. They can also increase the supply of money to stimulate growth.
While this reactive nature of monetary policy offers the strength of adaptability, it can also serve to exacerbate problems in the economy if a policy choice proves to be ineffective. This ties into the nature of monetary policy in the incumbent financial system that employs centralized decision-making processes. The vulnerabilities of this system have led many to distrust it and seek alternatives. This is where the allure of cryptocurrencies comes in, emerging from their decentralized, algorithmic nature.
How Is Crypto Different?
Cryptocurrencies operate fundamentally differently from the traditional fiat system. Their decentralization implies that they don’t come under any central authority’s purview, and their monetary dynamics are dictated by algorithms rather than human decisions. Digital assets are designed to behave differently from traditional financial instruments, reflecting the foundational vision behind this asset class to create a system free from the structural issues of traditional finance.
This vision is why we have seen the emergence of a wide array of cryptocurrencies, each experimenting with traditional financial mechanics in their own way and attempting to improve upon them. A common defining characteristic is the interplay between inflationary and deflationary dynamics. Note that the terms ‘inflationary’ and ‘deflationary’ here regard changes in coin supply rather than changes in price, as in traditional economic usage.
Inflationary vs. deflationary cryptocurrencies
Inflationary cryptocurrencies are designed to experience a gradual increase in their circulating supply over time. This happens through various mechanisms, including mining or staking. The basic idea is similar to fiat currencies, where central banks print more money. Inflation is introduced to incentivize network security and participation and to replace lost coins. However, the increased supply, if surpassing demand, can lead to depreciation over time, much like in fiat currencies.
Deflationary cryptocurrencies, on the other hand, are designed to decrease in supply over time. This happens through various mechanisms, such as burning or halving, where a certain portion of tokens is permanently removed from circulation. This reduced supply can lead to an increase in the value of each token over time if demand remains the same or increases, rewarding long-term holders.
Bitcoin
Bitcoin employs both inflationary and deflationary dynamics. It is inflationary due to the introduction of new units into its circulating supply through mining. Conversely, it is deflationary due to its halving and scarcity mechanisms. Bitcoin’s inflation rate is designed to decrease over time as the amount of new units created and earned by miners halves roughly every four years. Furthermore, the total supply of BTC is capped at 21 million units. Once all bitcoins have been mined, which is expected to occur around the year 2140, there will be no more new units produced, ultimately introducing scarcity and making it a deflationary asset in the long term.
Bitcoin as a Long-Term Store of Value
The total supply of BTC is capped at 21 million, introducing scarcity – a stark contrast to potentially infinite fiat currencies. Furthermore, bitcoin’s value doesn’t directly correlate with traditional financial markets, insulating it from economic changes that impact traditional currencies. These factors can make BTC a potential store of value even in inflationary times.
The potential of bitcoin as a safe-haven asset can directly be seen through its price performance in recent times. Since the beginning of 2023 to the end of October, bitcoin has risen in price by roughly 108%, outperforming traditional safe-haven assets such as gold and bonds by a considerable margin. Of course, considering that BTC has been around for less than two decades, these traditional investments have a more convincing track record spanning a much longer period of time. Still, the persistence of bitcoin’s upward trajectory cannot be overlooked.
While BTC’s recent price performance is impressive, its viability as a safe-haven asset and long-term store of value isn’t a given. Past records aren’t a reliable indicator of future results. Critics often highlight the volatility of bitcoin’s price and cite the risks associated with cryptocurrencies themselves, including regulatory uncertainties and security concerns.
Arguments Against
The argument for bitcoin as a safe-haven asset rests primarily on its limited supply, perceived store-of-value capacity, and resilience against traditional market fluctuations. Nevertheless, the idea is far from undisputed. Cryptocurrencies are often associated with high volatility, which can serve as a double-edged sword. On one hand, this can result in high rewards; on the other, it can lead to significant short-term losses.
For instance, bitcoin’s price skyrocketed to nearly $20K in December 2017 before falling to under $3.5K a year later in December 2018. More recently, bitcoin hit its all-time high of over $68K in November 2021 before falling back down to under $16K a year later in November 2022. In addition to this record of price volatility, there are the wider risks of cryptocurrencies in general, which include regulatory uncertainty and security threats.
Nevertheless, these issues stem from the emergent nature of digital assets, the landscape of which is still being mapped. As cryptocurrencies continue gaining traction as an established asset class, regulatory clarity and increased adoption will help alleviate the concerns above. For now, the potential viability of bitcoin as a safe-haven asset cannot be denied.
Closing Thoughts
In a world where the deeply interconnected global economy is weighed down by conflict, pandemics, and widespread inflation, the need for assets that improve people’s chances of preserving the value of their savings and capital is stark. The dialogue around bitcoin’s potential as a safe-haven asset is ongoing. Given its built-in properties and resilient market performance in recent times of market turbulence, many people have begun to view bitcoin as offering a new, innovative medium for storing value and hedging against economic uncertainty. Time will tell if BTC’s safe-haven properties continue to shine through in the long term.
