• Maxim Bederov, serial entrepreneur, venture capitalist, and blockchain technology expert at n/a


• 30.09.2020 12:30 pm
bitcoin

The negative debt crisis is coming and cryptocurrencies could be a useful tool for investors in the event of a market downturn.

According to the Bloomberg Barclays Global Negative Yielding Debt Index the world now has $17 trillion of negative yielding government debt, up from $14 trillion in August, plus over $1 trillion in negative yielding corporate debt. These numbers are going up at unprecedented rates.

“Thirty percent of investment-grade securities now bear sub-zero yields,” writes Bloomberg’s John Ainger, “meaning that investors who acquire the debt and hold it to maturity are guaranteed to make a loss. Yet buyers are still piling in, seeking...at least to avoid greater losses elsewhere.” 

European powerhouse Germany is perhaps our best example as to the natural end point for negative yielding debt. The country recently auctioned off €2.3bn of 10-year debt at a record low yield of -0.41%. July’s bond auction promised only slightly higher yields of -0.26%. Then in August the country crossed the Rubicon by selling 30-year bonds at negative yields for the first time ever.

These negative rates have become standard in Eurozone banking. And Germany — whose economy is on the brink of recession — is inching ever closer to defaulting on its sovereign debt.

Of course equities are still producing solid returns for retail and institutional investors alike.

But by many estimates the world’s major stock markets are wildly overvalued. Conventional wisdom says that record-high stock markets like the S&P 500 (over 3,000 at time of writing), are driven by rising company earnings. But the S&P is in its first earnings recession in three years as earnings per share turn negative for the second consecutive quarter. Values are expected to drop further in the third quarter.

How is this possible?

Quantitative easing - which the European Central Bank restarted on 12 September - and negative interest rates have left us with a situation where we have trillions upon trillions of newly-created currency sloshing around the global economy desperately seeking any kind of positive return.

The genesis block

The origins of cryptocurrency lie in Satoshi Nakamoto’s response to the failure of central banks to respond effectively to the biggest economic crisis of our generation.

Text included in Nakamoto’s genesis block for Bitcoin contains this headline from British newspaper The Times.

The 3 January 2009 article reads: “[UK Chancellor] Alistair Darling has been forced to consider a second bailout for banks as the lending drought worsens. The Chancellor will decide within weeks whether to pump billions more into the economy as evidence mounts that the £37 billion part-nationalisation last year has failed to keep credit flowing. Options include cash injections, offering banks cheaper state guarantees to raise money privately or buying up ‘toxic assets’.”

Taking current news as a marker we can see that monetary policy has not altered in the decade since Bitcoin was invented.

The new abnormal

In June 2019 the head of the US Federal Reserve Jerome Powell confirmed what many economists had feared. That extreme monetary policy levers like quantitative easing - pumping free money into distressed economies to shore up growth - were now the new norm.

“Perhaps it is time to retire the word ‘unconventional’ when referring to tools that were used during the [2008] crisis,” Powell said in a Chicago speech on monetary strategy. “We will act as appropriate to sustain the expansion.”

On 18 September Powell slashed US interest rates for the second time inside seven weeks, this time by 25 basis points, in order to prop up the slowing US economy by cutting borrowing costs for households and businesses. These two rate cuts represent the first and second times the Fed has cut rates since the economic crisis of 2007-2008.

Another rate cut, perhaps to 1.5%, is expected in the coming months.

Across the Pacific, the cycle also continues. The European Central Bank (ECB) has voted to restart quantitative easing and to lower interest rates even further into the red, to minus 0.5%. Bank president Mario Draghi said the ECB’s new money-printing exercise would buy up government bonds at rate of €20bn every month, while the negative interest rates would force banks to loan out even more money. At the same meeting the ECB also slashed its growth forecasts for Europe as it warned that economic conditions were deteriorating more quickly than expected.

And there is further bad news in US lending markets.

The Federal Reserve Bank of New York approved a $53 billion cash injection on 18 September in an attempt to de-stress overnight lending markets. This money will again be used to buy up US Treasury bonds and other securities. It is the Fed’s first intervention since 2008.

Writes CNN: “The episode demonstrates evidence of emerging strains in financial markets and raises concern that the Federal Reserve could be losing its grip on short-term rates.”

The wider picture

Bridgewater Associates hedge fund magnate Ray Dalio, who has a net worth nearing $20 billion, speaks of a coming paradigm shift.

Dalio explained in a widely-shared July 2019 Linkedin post that “an unsustainable rate of debt growth that supports the buying of investment assets,” would herald this new trend. “It drives asset prices up,” wrote Dalio, “which leads people to believe that borrowing a buying those investment assets is a good thing to do. But it can’t go on forever because the entities borrowing and buying those assets will run out of borrowing capacity while the debt service costs rise relative to their incomes by amounts that squeeze their cash flows.”

When the pressure of the squeeze becomes too great, that’s when we start to see defaults.

When one major institution defaults, another tends to follow. Such is the extremely interconnected nature of commercial and investment banking. Bank A owns the debt of Bank B, and Bank B owns the debt of Bank C and so on.

It is our thesis that in times of economic stress, with the possibility of market shock increasing, that Bitcoin and cryptocurrencies can provide an option for investors as a hedge against downturns.

Gold is an obvious flight-to-quality choice but there is literature to support the fact that Bitcoin and cryptocurrencies provide this too.

Is Bitcoin a hedge?

There is some evidence at least for Bitcoin’s utility as a hedge against wider uncertainty and as a useful diversification method for portfolios at large.

Konstantinos Gkillas and François Longin use multivaritate extreme value theory to find “a low extreme correlation between Bitcoin and gold, which implies that both assets can be used together in times of turbulence in financial markets to protect equity positions.”

In the Journal of Cogent Economics and Finance (Volume 7, 2019), Anders Stensås, Magnus Frostholm Nygaard, Khine Kyaw and Sirimon Treepong Karuna argue that Bitcoin does act as a diversifying tool for investors, however they note that Bitcoin’s properties vary across regions.

In the aftermath of China’s stock market bubble bursting in 2015, they found “statistical evidence of Bitcoin being a strong safe haven for Japan, Germany, France, Canada, China and South Korea. Moreover, for the same period, Bitcoin act[ed] only as a weak safe haven for USA, UK, Brazil, Russia and India.

“Interestingly, we find evidence of Bitcoin being a strong hedge for investors in the developing markets especially for Russia, India and South Korea, and a weak hedge for Brazil. As such it could be beneficial for investors with exposure to developing countries to include Bitcoin in their equity portfolios for hedging purposes.”

They conclude: “We find evidence of a qualitative difference between developed and developing markets with regards of Bitcoin’s capability as a hedge. Bitcoin acts as a strong hedge for investors in most of the developing markets, but only as an effective diversifier for investors in developed markets, regional indices and commodities...Investors with exposure to equity and commodities could benefit from having a position in Bitcoin in times of extreme uncertainty.”

Investor options

The launch of regulated Bitcoin bonds is a natural expansion of fixed-income product ranges. An institutional-grade crypto-only bond, from a company regulated by the UK’s Financial Conduct Authority watchdog, went live in Europe in July. The bond mimics traditional government or corporate debt with interest of between 6.6% and 8% depending on how long investors are willing to assign their cryptocurrency to the bond. 

With ISIN numbers, availability through the Bloomberg Terminal and a maximum investment cap of 10,000 BTC it is aimed squarely at the institutional marketplace.

While the US Securities and Exchange Commission has repeatedly delayed decisions on whether Bitcoin-based exchange-traded funds (ETFs) can come to market, there are other options for large investors who want lower-risk exposure to cryptocurrency in their portfolio.

The Wall Street Journal reported recently how the two firms at the centre of Bitcoin ETF proposals had started to offer shares in a limited version of their Bitcoin tracker to hedge funds and large institutional investors.

Switzerland’s SIX commodities exchange has the Amun Crypto Basket ETP (ticker name $HODL) which tracks the prices of the most liquid coins: Bitcoin, XRP, Bitcoin Cash, Ethereum and Litecoin. Like all exchange-traded products it is 100% physically-backed by the assets whose prices it tracks.

In recent months Amun has also added single-asset trackers for Bitcoin (ABTC), Ripple (AXRP) and Ethereum (AETH) which compete with trackers for gold, cocoa and crude oil for the exchange’s most traded ETPs.

Just one point to note: this article should not be used as investment advice. Please seek advice from an independent financial adviser before making investment decisions.

Maxim Bederov is a serial entrepreneur, venture capitalist, and blockchain technology expert. Has nearly two decades of experience in financial services. He has been active in blockchain technology and the digital asset space since 2014.