Since their conception in 2008, we have heard that cryptocurrencies and specially Bitcoin as an authentic store of value. However, this function has been historically exclusive for fiat money. In this post we will define what is a store of value and how much the cryptocurrencies fit in its definition. Additionally, we will analyse the effect of inflation and volatility into this fulfillment. Lastly, we will see some use cases of savings through Bitcoin and their risks.
What is a store of value?
We can define a store of value as anything which maintains its value over the time. This property is not exclusive for the money, as it is also shared with other assets as the precious metals like gold. However, not all the currencies can presume of having this property.
Some currencies as the Argentinian “peso” or the Venezuelan “bolivar” suffer of hyperinflation episodes, which devalue them constantly. When a given currency looses part of its value over the time, it becomes unreliable for the families to maintain their savings. All the currencies suffer at some point the effects of inflation. Additionally, they can loose part of their value as a consequence of an economic downturn. These phenomena do not last for ever, so their impact in the store of value character is low.
However, when these episodes become permanent or last too much time, the people remove their confidence in the value of the currency. Consequently, they look for different stores of value for their savings, as the american dollar or the gold. Therefore, we can only speak about a store of value when the value of the asset remains stable or with low variation over the time. That is to say, the purchasing value of the people remains unchanged regardless of the economic situation. This is a key aspect when deciding what to do with our savings.
On the other side, the gold does not loose any value over the time. By definition, it has no expiration, so it serves as a shield during inflation episodes. However, its value depends on the market, and it is not officially recognized as a payment method, so it is not equivalent to money.
The effect of inflation
When we talk about stores of value, what comes to our mind are the strongest and most stable currencies, as the pound or the euro. In these financial systems, the Central Bank has very severe politics to control the inflation rate. This control comes out from the management of the monetary supply, which affects directly to the money in circulation.
When the inflation is under control, the citizens believe that their purchasing money will remain intact. Obviously, the longer is the time window, the more difficult will be to maintain the value of the currency. However, in the short term, it will serve well as a store of value.
In other economies, the inter-annual inflation rate can be above 50%. When the local prices move at that rhythm and the currency is weak, the purchasing power decreases very quickly. In this context, the transfer of savings to other stores of value such as the gold becomes even more importance.
Due to this, the effect of inflation in any currency is clearly negative. The inflation rate harms the purchasing power of the people and, therefore, the capacity of the currency of serving as a store of value. When this situation lasts too long, the currency becomes totally unreliable, which effectively prevents the people to use it as a shield for their savings.
The inflation in cryptocurrencies
The cryptocurrencies such as Bitcoin, for example, have a restricted supply. It exists a maximum quantity of money supply that can be created, which means that we are talking about a non inflationary currency. Additionally, its performance in the last years turns it in a very attractive asset to invest in during episodes of hyperinflation.
That it is reason why the effect of inflation in currencies such as Bitcoin is quite neutral. If there is no decrease in the value of the currency, then the purchasing value remains as well. If we link this with the low correlation between the performance of Bitcoin and the economic context, then it is easy to see that Bitcoin becomes reliable during economic downturns.
Other cryptocurrencies such as Ethereum do not have a limited supply, so the inflation rate could have negative effects. However, as they are not official payment methods, the pricing of any products cannot be affected, as they are defined in the local currency.
The effect of volatility
We can define the volatility as the maximum price variation we can expect from a given asset for a certain time window. It is associated to the implicit risk of the asset, and it represents the maximum loss for a given period. From the point of view of investors, the volatility is something valuable, even attractive to invest in. However, when we are talking about savings, volatility is one of our worst enemies.
If our savings are denominated in a currency with high volatility, then our money will be very exposed. The high volatility implies uncertainty about the value of our saving in the future. This makes more difficult to take purchasing or investment decisions in the near future. The same is applicable to other assets such as bonds, equities or commodities. Therefore, any store of value should be able to presume of low volatility.
The volatility in cryptocurrencies
The cryptocurrencies are once of the most volatile assets in the financial industry since their conception in 2008. The high proportion of retail investors and the lack of regulation are some reasons for this volatility, but not all of them. In these cases, the investors can loose a significant part of their savings. Moreover, the fact that the cryptocurrencies are not official payment methods restricts even more their usefulness.
It is true that their volatility has been decreasing over the years, but it is still too high. The institutional investors have provided some stability, and there are many use cases on going. Additionally, the correlation with other financial assets is growing, which allows to predict with more accuracy their value. Due to all these elements, the global volatility is decreasing, although is not low enough to consider the cryptocurrencies as stable assets.
Cryptocurrencies as store of value
We have now a clear idea of the effect of inflation and volatility in our savings. If we take these effects in the context of cryptocurrencies, their negative consideration as store of value should be clear. However, we have observed that people in several countries effectively use them as store of value.
When we have a context of high inflation or local currency devaluation, the cryptocurrencies jump on the scene. Moreover, if we take into account that there is no control by neither public nor private entity, the context for them is even more positive. The people can use them to invest their saving trusting than they will remain valuable after the crisis. But we have said that the cryptocurrencies did not serve as store of value, is not that true?
As always, it depends on the context. In a solid and stable economy, the cryptocurrencies make no sense as store of value. However, in the opposite context, the scenario may be favorable. In any case, the cryptocurrencies are always a difficult choice due to the uncertainty of their future performance. However, there are are some other ways to maintain our savings using the cryptocurrencies. Let’s see two of them:
Use cases: Bitcoin mortgages
We saw some years ago an increase in multicurrencies mortgages, for example with the Japanese yen. The underlying idea is to have the mortgage linked to an index with a lower interest rate than the European euribor. This could imply than the lower variable interest rate could allow a cheaper mortgage fee. However, this was proved to be a bad decision due to two different reasons.
Firstly, the new interest rate did not have to be necessarily lower than euribor. Its performance was not guaranteed anyway, so the clients were equally exposed to an interest rate. This is what we usually know as the “interest rate risk”. Additionally, this interest rate was unlinked to the local economy, which implied a worse knowledge of it.
Secondly, there was an additional risk related with the foreign currency (“exchange rate risk”). If the price of the currency of our mortgage raised in value against the local currency, the monthly fee was higher. This is because we need more local currency to pay the same amount of foreign currency. Even when our mortgage is denominated in foreign currency, our salary remains in local currency, and that is why we are more exposed.
This example is also applicable for cryptocurrencies. In this case, we would not have any interest rate risk, but we would maintain the exchange rate risk. This is even more dangerous if we have in mind the high volatility of the cryptocurrencies. Therefore, if we want to use the real state as store of value for our savings, it is better to invest in local currency. It is possible to have success doing it through cryptocurrencies, but it is also riskier. The more risks we face for our savings, the less likelihood of maintain the value of them.
Use cases: remittances transfer
We have also seen the use of cryptocurrencies to transfer money without any banking entity involved. For economies such as El Salvador this is a very important source of incomes. In fact, the banking industry makes lots of benefits from transfer fees. In the case of the cryptocurrencies, these fees are much lower, which allow the sender to save costs and the receiver to keep most of the money.
Therefore, the appearance of any cheaper alternative such as the cryptocurrencies can move the savings from the local currency to the alternative. This is significantly more frequent in economies where the remittances transfer has a considerable weight in the system. In fact, this is one of the most important arguments which the government claimed when declared Bitcoin as official payment method in the whole country.
As we have seen, under certain conditions such as hyperinflation episodes, weakness of the local currency, etc., it is normal to think in cryptocurrencies as stores of value. However, the cryptocurrencies are always exposed to high price variation. Moreover, not all of them are non-inflationary.
Therefore, we cannot talk about cryptocurrencies as store of value with the same confidence we would do with other assets. If we compare them with other forms of money, the inflation and the volatility must form part of the discussion. The lack of regulation of cryptocurrencies add uncertainty on their future performance. However, under some circumstances, their use can make perfect sense.
In fact, we have no way of anticipating where the price of cryptocurrencies will go. Given the fact that the goal of most investments is to protect our savings, it is difficult for the cryptocurrencies to reach it. However, it is possible that, if your goals are different, the investment in cryptocurrencies is completely justified.