Hedging Against Downside Risk with BTC

Many analysts are of the opinion that there is merit in using Bitcoin (BTC) as a safe-haven contrarian investment for hedging purposes. A caveat is in order: "Volatility plays a major role and the BTC value fluctuates at any given time. ResearchGate conducted extensive analysis into the merits of Bitcoin and gold for hedging purposes and their findings were definitive. Bitcoin cannot be regarded as a hedge against geopolitical uncertainty. However, BTC is a lot more responsive to economic policy uncertainty shocks.

Nonetheless, the findings do not rule out the possibility of using BTC as a ‘weak hedge’ against economic policy uncertainty shocks. Recall the $20,000 spike per unit in December 2017 when speculative sentiment was overwhelmingly bullish, but stock markets were roaring too. The correlation between uncertainty and demand does not always hold true. At the very least, BTC should be considered as part of a portfolio diversification strategy for the purposes of hedging against geopolitical uncertainty. It is against this backdrop that we examine the merits of hedging against downside risk with Bitcoin.

In Extreme Returns Cases, Bitcoins Can Be a Hedge, Say Authors

An op-ed in Forbes by Professor Panos Mourdoukoutas, the Chair of the Department of Economics at LIU Post in NY, ran the headline, ‘Bitcoin is the New Gold: Study.’ This in-depth piece draws its conclusions from a myriad of sources, by evaluating overall market activity and the impact on Bitcoin’s pricing mechanism. In stark contrast to the analysis conducted by Research Gate, this market expert alluded to a University of Pretoria paper from the Department of Economics.

The listing of safe haven assets is generally well known around the world, and includes the likes of gold bullion, gold ETFs, gold stocks, the Japanese yen (JPY), the Swiss franc (CHF), and Treasury notes. The authors of the study, Longin and Konstantinos, asserted that there is a correlation in extreme returns cases. When a stock market booms or a stock market crashes, Bitcoin can serve as a hedge against market volatility.

According to the authors, the correlation of ‘extreme returns’ is pronounced during peaks and troughs in the market, much like gold. Equally interesting is the finding that the correlation between Bitcoin and gold is low. In a sense, this makes them perfect complements during geopolitical uncertainty, economic volatility, and wild fluctuations in speculative sentiment. Both financial instruments tend to have a store of value function and pricing is a product of demand/supply considerations. Of course, Bitcoin’s tenure in the market is extremely limited, compared to gold bullion. Yet the veracity of such claims is strictly limited to the studies that one reads. If the data can be made to fit the narrative, Bitcoin can serve as a hedge against volatility.

Cautiously Receptive Approach Required for BTC Hedging

A well-rounded understanding of the financial markets can serve the interests of traders much better. The economic uncertainty generated by political shocks in Argentina present an interesting case for Bitcoin as a hedge. Back in 2019, election news from Argentina sent markets into a freefall. The left-leaning Fernandez was defeated and this resulted in the Argentinian Merval dropping 48% in a day. This placed tremendous pressure on the ARS which depreciated sharply against USD.

In fact, the exchange rate has consistently been degraded since 2010, with more value shedding expected in 2020. It appears in this particular instance that Bitcoin benefited from the volatility, given that it was an extreme case. Whether it's true that Argentinians turn to BTC amid growing depreciation in their own currency is up for debate. Yet Bitcoin rose almost 50% against the ARS during the time in question.

It would be a spurious and sweeping assumption to draw conclusions about Bitcoin and global uncertainty. At times, Bitcoin has performed remarkably well as a hedge, and at others not. An economist named Alex Kruger believes that people are mis-attributing the true hedge resources from the faux hedge resources. In this case, the true hedge he believes is the USD (the greenback) while the faux hedge is BTC (Bitcoin).

Many similar examples abound across Latin America, notably Venezuela. There is a degree of concern that too many people make sweeping assumptions that Bitcoin is the ideal hedge against global market uncertainty, while the truth it appears is somewhat opaque. Bitcoin is by its very nature highly unstable and governed only by demand/supply considerations in the financial markets. Traders and investors are urged to be cautiously receptive to BTC/USD and other pairings.