One of the main achievements in the reputation of the cryptocurrencies has been the consideration of Bitcoin as a safe investment by many of its investors, replacing the gold as the main standard. This has great implications given that the gold has been the traditional life insurance for investors during the economic uncertainty. Therefore, if Bitcoin finally takes that place, its reputation would improve as well as its demand by the investors. However, there are not so much assets that can call themselves as safe investments. At this point, several factor must be analyzed in order to reach a consensus regarding the consideration of Bitcoin as a safe investment.
In this post we will define what a safe investment should be. We will analyze the characteristics it must fulfill and we will check how goo is the performance of Bitcoin on them. After that, we will be able to decide if remains as a common financial asset or whether it could make sense to use it as an economic insurance in times of uncertainty.
What is a safe investment?
As commented earlier, a safe investment is considered an asset to invest in times of financial crisis, high inflation periods or moments in which the local currency does not maintain its value. On these environments, these assets are used to perform better than the average, which is important for the people to save their money and maintain their purchasing power. In fact, these assets are even more secure than the banking deposits, which are the most liquid asset after the cash money.
These assets have traditionally shown a low correlation (or even negative) with the performance of the classic indicators. This means that the performance is quite independent in terms of statistics, which is very important in negative contexts. The implications for the safe investments are very clear. When the market falls, these assets “does not have to fall”. This does not mean it will go up, but whatever it does, it will be quite independent from the context.
Because of this, the value of a safe investment is not in the performance per se during economic uncertainty, but in the diversity of the portfolio. A diversified portfolio minimizes the risks of economic losses in environments of general downfalls. Additionally, it allows to be better isolated from the global movements of the markets, maintaining the stability of the investments.
Characteristics of a safe investment
As we have seen earlier, there is no a single criteria to define what a safe investment is. In fact, its definition is more like a general agreement among the investors community, and it has changed over the time. However, what we can confirm is that there are some common characteristics which are intrinsically linked to this concept. These elements are listed below:
- Low risk
- Uniform regulation
Let’s see how these factors define the safe investments and how well are fulfilled by Bitcoin and gold.
The scarcity of any asset is one of the most important factors for the protection against inflation. It is important to remember than the inflation occurs because there is more money in circulation than the economy can absorb, so the automatic response of the system is with an increase of prices. Both Bitcoin and gold can presume of having a limited issuance. For the gold, this limitation comes from a physical scarcity, while the one from Bitcoin is included in its protocol. This allows both Bitcoin and gold to be non-inflationary assets.
This situation does not happen in the case of the traditional currencies controlled by the Central Banks. In fact, the traditional currencies as the Pound, the U.S. Dollar or the Euro are also considered as safe investments. In these cases, the assets do not fulfill the scarcity, but the strength of the underlying economies is safe enough as protection against inflation.
Therefore, the scarcity is not a crucial element in a financial asset, but it is very important as a protection against the inflation. Given that this is one of the scenarios the safe investments are needed for, we will consider this element as a necessary factor.
Apart from protection against inflation, the safe investments should also protect the savings of investors in periods of economic turbulence. Because of that, the safe investments should be able to offer low financial risk in these environments. If we analyze the performance of Bitcoin and gold during March 2020 (COVID-19 pandemic), we can obtain a good example. In that period, the whole economic context was shaken. During that month, the gold fell more than 8%, while the standard equity assets fell 30-35%.
This downfall of 8% only lasted for a few weeks, and after that started a positive period. In the case of Bitcoin, the downfall reached 25% down and it took two months to recover its value. With this in mind, it is not clear the role of safe investment of Bitcoin, as it did not act as a protection during the worst period of the pandemic financial crisis.
There is an element similar to risk which is the volatility. It refers to the easiness by which we can predict the performance of any asset for a time window. When the asset has a low volatility, it is very likely to experiment a neutral performance, without severe peaks or drops. On the other side, a high volatility will mean a high dispersion in the expected performance (both positive or negative). Based on this, the volatility of a safe investment should be low, to minimize the uncertainty of the performance of our portfolio.
The common equity has an annual volatility of 20%, while the one for gold is lower, near to 15%. However, the observed volatility for Bitcoin is almost 80% which makes very unpredictable. This provokes Bitcoin to be much worse safe investment as gold, because precisely what we are looking for in periods of economic uncertainty is stability and predictable performance in our portfolio. This is what will protect us from the downfall of the market.
At this point we can confirm that the correlation between two assets refers to how similar their performance are. Traditionally we have observed a high correlation between the equity assets of one economy and the main macro indicators of that economy. This is due to the fact a reasonable growth of the trade balance, the GDP or the public expense usually implies a correspondent growth in the domestic companies, and, therefore, to the value of their shares. In fixed income assets, however, the performance is usually linked to the evolution of the interest rates defined by the Central Bank.
Other assets as commodities, currencies, etc. have also high correlation among them. Based on this, a safe investment should have a low correlation with the economic environment. This way, its performance would be isolated enough in periods of financial crisis.
Regarding this, neither gold nor Bitcoin have a strong positive or negative correlation with the traditional financial assets. Thanks to this, we could consider both as safe investments. Additionally, the low correlation allows them to diversify our portfolio. Remember that a diversified portfolio is important to minimize the risk of losses in every investment.
Other factor which is important to have in mind is the existence of a uniform regulation in the financial markets. This guarantees protection for the investors in case they need to recover their funds. Currently every country in the world recognizes the gold as a financial asset. Furthermore, it counts with a huge base of investors, and a quite uniform treatment in terms of taxes.
In the case of Bitcoin, however, every country has its own criteria in defining whether it can be treated as a financial asset or not. In come countries every activity around cryptocurrencies is clearly forbidden, while other accept them as official mean of payment. This uncertainty makes hard to consider Bitcoin as a safe investment. If any investor has cryptocurrencies in the portfolio, he/she will be exposed to the local regulation, which could imply a legal risk.
A good legal treatment to Bitcoin as a financial asset would help it to establish in the industry. Additionally, the investors would feel safer with this type of products, and the cryptocurrencies would be better accepted. Until then, we cannot expect a stable consideration of Bitcoin as a safe investment.
Last but not least, we need to talk about the liquidity of the safe investments. The liquidity is the capacity of any financial asset to become cash money in the shortest time possible. There is, therefore, some assets really liquid, as the bank deposits for example. Other assets as the real state could be more profitable, but not so liquid for sure. In a negative economic environment a liquid safe investment allows us to recover quickly our funds.
However, liquidity does not only imply velocity in becoming cash. It also refers to the lose of money (the cost) during that conversion process. It means that if you need to lower the price down 20%, then you cannot talk about a safe investment.
In fact, the vast majority of safe investments fulfill both conditions simultaneously. On one side, they can be easily converted in cash (bonds, currencies, gold, etc.). On the other side, thanks to a very depth market, the cost of this conversion is minimal. They are, therefore, very liquid assets which allow to recover the money quickly and with plenty of guarantees.
In this sense, Bitcoin has been growing a lot among the investors community. Its demand is getting quite diverse, which helps to improve the ways to invest in it. There are a lot of exchanges, and some countries even accept Bitcoin as a mean of payment. Because of that, we can confirm that Bitcoin can compete with gold as a safe investment, at least, in terms of liquidity.
Conclusion: Is Bitcoin a safe investment?
Although Bitcoin and the gold may share some of the basic characteristics of the safe investments, it is not clear that they are equally useful for the investors. In fact, Bitcoin can be currently used against inflation or when the local currency is depreciating too much, but it still lacks some of the basic protection elements in times of negative environments, when they are most needed.
In some years, once Bitcoin has finally settled among investors, the regulation becomes uniform and the volatility does not represent such a threat for the investors, we may talk about a new safe investment. Until then, Bitcoin has a too high intrinsic risk to be considered as safe in periods of financial instability. However, this does not mean it can’t obtain certain positive performance under determined environments.