Thursday, July 30, 2020

Does the COVID-19 pandemic change the investment case for cryptocurrencies?

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The COVID-19 health crisis forced the world to move online, accelerating digital transformation and highlighting the increasing importance of electronic transactions. What does this mean for digital currencies? Are they likely to benefit – or will concerns over their future remain?

 

Investors seeking new assets

The rapid spread of coronavirus (COVID-19) has dramatic impacts on financial markets all over the world. It has created an unprecedented level of risk, causing investors to suffer significant loses in a very short period of time. This paper aims to map the general patterns of country-specific risks and systemic risks in the global financial markets. It also analyses the potential consequence of policy interventions, such as the US’ decision to implement a zero-percent interest rate and unlimited quantitative easing (QE), and to what extent these policies may introduce further uncertainties into global financial markets.

Keywords: Coronavirus, Financial markets, Pandemic, Quantitative easing, Systemic risk

On March 11, 2020, the World Health Organisation (WHO) declared the coronavirus outbreak a global pandemic. Financial markets responded immediately. Investors panicked and an equity sell-off began. In the United States, the Dow Jones fell by 10 percent that day, its worst daily performance since the 1987 Black Monday market crash. Trading was halted to avoid greater losses.

The International Monetary Fund also warned that month that the world would witness its worst recession since the Great Depression. In an historic development, oil prices turned negative in April (see our previous analysis on energy investments).

The lure of traditional safe havens like gold proved irresistible. The World Gold Council noted that global demand for gold was steady in the first quarter of 2020 (at 1,083.8t), while gold-backed exchange-traded funds attracted huge inflows (+298t).

This situation also put the spotlight on alternative investments, and in particular, on non-traditional monetary assets like cryptocurrencies.

Volatility remains

There has been tremendous interest in digital currencies in the past few months, reported CoinTelegraph. However, this has not always translated into price appreciation. Just like traditional financial assets, Bitcoin – the most popular cryptocurrency – has had a rough ride, with its price collapsing by 37 percent in a single day mid-March. Its price has since recovered, in part due to a boost following its “halving” on May 11 when coins were harder to mine, a process that happens on a regular basis to support the market.

Source: Refinitiv

The rapid appreciation of the cryptocurrency since its creation is well documented. However, the performance of Bitcoin, like so many other “cryptos”, has been extremely volatile, as the chart below shows:

Source: Refinitiv

Goldman Sachs recently warned in a markets outlook presentation about Bitcoin’s historic volatility (which it estimates at 76 percent annually) and argued that cryptocurrencies “are not an asset class.”

“We believe that a security whose appreciation is primarily dependent on whether someone else is willing to pay a higher price for it is not a suitable investment for our clients,” the bank noted.

Source: Refinitiv, Goldman Sachs

“Despite that most cryptocurrency ledgers are permanent and auditable public records, cryptocurrencies nevertheless abet illicit activities such as Ponzi schemes, ransomware, money laundering, and darknet markets,” Goldman Sachs pointed out.

Goldman Sachs remarked that the market suffers from lack of trust. The origins of Bitcoin are still shrouded in secrecy. At the heart of the Bitcoin universe is blockchain, a decentralised ledger technology with huge disruption potential that appeared seemingly out of the blue in 2008 in a paper published in an obscure online community. The real identity of its creator remains unknown to this day, and many theories abound.

Nevertheless, Bitcoin has kept growing and is the undisputed market leader, with a capitalisation of about U.S.$170 billion out of an overall market worth over U.S.$260 billion, Coinmarketcap figures show. Today, there are hundreds of digital currencies, with other popular ones including Ethereum, Tether and XRP.

However, the crypto market has witnessed many scandals, the latest being July 2020’s Twitter hack, when high-profile names like Barack Obama, Kanye West and billionaires Elon Musk, Jeff Bezos and Bill Gates were targeted on the social media platform in an apparent Bitcoin scam. Prior to that, the Mt. Gox heist dominated headlines in 2014.

Contrasting views

Yet there is another side to the story. In its latest Crypto Outlook report, Bloomberg argued that “something needs to go really wrong” for Bitcoin to not appreciate. Bloomberg’s view is that the significant move away from paper money, as seen during the recent lockdowns, and large amounts of quantitative easing could help independent stores of value such as gold and cryptos like Bitcoin.

“This year is about increasingly favourable technical and fundamental underpinnings for Bitcoin, and less so for the broader crypto market, in our view. Bitcoin ended 2019 at about U.S.$7,000, near the bottom of its range, favouring a shift toward the peak. Last year, the high was about U.S.$14,000, which would translate into almost double in 2020 if rotating within the recent band and means little in the big picture. The same forces buoying gold support Bitcoin, yet the supply of the crypto is more constrained. Adoption, by default, is the primary Bitcoin metric, and our indicators remain positive,” it said in the report.

For fans of cryptocurrencies, the negative narrative around them is unfounded and only serves the current monetary order. After the 2008 credit crunch, and the bailouts of major financial institutions, market players and the general public started to doubt conventional financial institutions, central bank action and its dominance on the issuance of currency. This supported the creation of alternative currencies like Bitcoin and other tokens, as a way to challenge the paradigm.

Watch for central bank action

Although cryptos and digital tokens are not considered to be legal tender, they could be one day, challenging traditional bank-based payment systems. The world’s largest central banks are becoming more open to them, especially after the COVID-19 pandemic stressed vulnerabilities in cash-based transactions.

Central banks were interested even before the health crisis, with the Bank for International Settlements (BIS) writing in 2019 that “payments are changing at an accelerating pace. Users expect faster, easier payments anywhere and at any time, mirroring the digitalisation and convenience of other aspects of life,” and that “there is significant public interest” in such a fundamental potential change.

Many central banks are looking at creating their own form of digital currencies (CBDCs), which could replace traditional money. A group comprising BIS, the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Sveriges Riksbank and the Swiss National Bank is investigating the potential case for CBDCs in their home jurisdictions. 

“Central bank digital currency could help counter the monopoly power that strong network externalities can confer on private payment networks. It could help reduce transaction costs for individuals and small businesses that have little or costly access to banking services, and enable long-distance transactions. Unlike cash, a digital currency wouldn’t be limited in its number of denominations,” wrote Dong He, deputy director of the IMF’s Monetary and Capital Markets Department in a post.

He pointed out that unlike bank transfers, crypto asset transactions can be cleared and settled quickly without an intermediary, which could make the whole system fairer. “The advantages are especially apparent in cross-border payments, which are costly, cumbersome, and opaque. New services using distributed ledger technology and crypto assets have slashed the time it takes for cross-border payments to reach their destination from days to seconds by bypassing correspondent banking networks,” he said.

In a nod to the potential of cryptocurrencies, He added that “we cannot rule out the possibility that some crypto assets will eventually be more widely adopted and fulfil more of the functions of money in some regions or private e-commerce networks.”

In the Middle East, the Saudi Arabia Monetary Authority (SAMA) and the United Arab Emirates Central Bank (UAECB) announced in January 2019 they would launch the common digital currency project ‘Aber’ for use in financial settlements between the two countries through blockchains and distributed ledgers technologies.

In terms of regulating crypto assets, Abu Dhabi Global Market (ADGM) and the Kingdom of Bahrain are the first two regulators in the region to address this emerging area of Fintech.

ADGM issued a guidance regulating initial coin/token offerings and virtual currencies in October 2017. This was later followed in June 2018 by a guidance regulating crypto asset activities in ADGM.

Meanwhile, Bahrain also registered a first in the region in February 2019 when it published regulations on crypto assets in the form of the crypto asset module of the Central Bank of Bahrain rulebook directive. The directive oversees matters including licensing, compliance, governance, capital, security and risk mitigation and issues licenses for regulated crypto asset services.

Disruption in the currency monetary system is on the cards. Whether Bitcoin or another cryptocurrency will become the big winner of this change is hard to foresee at this stage. However, in the past decade, and despite setbacks, cryptos have gained prominence among investors and are now a key player in the future of money and transactions. As they say, watch this space.

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