Are bitcoin investments the answer to the COVID-19 crisis?
Answer by Alfred Taudes, head of the Research Institute for Cryptoeconomics
Stephanie H.: Are bitcoin investments the answer to the COVID-19 crisis?
Originally, bitcoin was not intended as an investment. The inventor of the bitcoin, who is only known by the pseudonym Satoshi Nakamoto, wanted to create a currency that does not require any banks. Consequently, the paper he put online in October 2008 was entitled “Bitcoin: A Peer-to-Peer Electronic Cash System.” Bitcoin has been slow to establish itself as a real currency in developed economies. As an investment, however, it has broken all records.
High Return, High Risk
An investor who spent $1 on bitcoin on February 15, 2011, would have been able to sell their bitcoins for $45,631 after a period of 10 years, reaping an average annual return of 292%. However, bitcoin investors also had to persevere through some slumps. For example, bitcoin saw its value drop by 59% in the period from December 17, 2017, to February 2, 2018. In the case of bitcoin, high returns go hand in hand with high risks. The risk of bitcoin investments is relatively cheap, however, because the reward-to-variability ratio of bitcoin investments relative to government bonds (the so-called Sharpe ratio) is significantly higher than that of stocks.
From the darknet to Wall Street
So what were the reasons driving this development? Fixed-income securities have hardly yielded any returns, while the bitcoin offered an inherent potential for gains because it has kept attracting new groups of buyers. This meant that the value of bitcoin is more closely correlated with the number of tweets on the subject than with the performance of conventional assets. The latest upward spike was probably due mostly to a tweet by Elon Musk, bitcoin purchases by institutional investors, and a growing range of cryptocurrency services geared towards end customers.
COVID-19 emergency aid is fueling fears of inflation
Many observers point to the COVID-19 pandemic as one of the reasons for bitcoin’s growing popularity. To mitigate the effects of the lockdowns imposed to combat the spread of the pandemic, the central banks significantly expanded the money supply: In Q4 of 2020, the M3 money supply increased by approx. 11% year-over-year in the euro area, and in the US, the M2 money supply grew by approx. 25%. So far, these measures have not led to rising inflation rates. For investments, what really counts are people’s expectations, however. This means that for an investor who expected inflation rates to go up at the time when the COVID-19 relief measures were launched, investing in bitcoin was indeed a valid response to the coronavirus situation. In the absence of bitcoin, gold would have been the natural alternative. The advantage that bitcoin and gold both share is that the supply is limited. Gold is produced through physical mining, and bitcoin is produced through digital mining. In contrast to gold, however, bitcoin can be freely subdivided and traded without limits. For this reason, more and more companies are starting to buy bitcoin. Tesla, for example, recently purchased $1.5 billion worth of bitcoin.
What will come after COVID-19?
The question is whether bitcoin will continue to benefit from the COVID-19 crisis in the future. Eventually, every pandemic has an end, and if the inflation rates refuse to go up, this might have negative effects on the performance of bitcoin. Potential adjustments in the stock markets that may occur once the relief measures are phased out may also turn out to be problematic. Today, bitcoin investments are more widespread among traditional investors than they were in the past, so they could be affected by selling pressure. The bottom line: Bitcoin investments have been one of the answers to the COVID-19 crisis, but it is unclear whether they will retain this status in the future.
Alfred Taudes, head of the Research Institute for Cryptoeconomics