The rapid spread of the corona virus is something that the public simply did not expect. It caught most of us completely unprepared, changing up our life in all sorts of unpredictable ways, including finance. For most people now is the time to adjust their financial holdings. This is what has happened during the last two weeks as investors were selling all types of financial assets they had in their portfolio. The flight to safety pushed many people into US dollar. However, the safety of US dollar was also put in question with announcement of upcoming quantitative easing and other money supply increasing measures.
Having served my tenure as the head of sales at the Wealth Management Division of UBS, the world largest wealth management bank, I learned that in the time of crises the speed of adjustment of the client portfolio can have a crucial influence on its overall long-term performance.
However, the key problem here is to decide how to switch. When everything is on fire it is difficult to see what will save your savings. Everybody is looking for the safe-haven assets which are negatively correlated to the overall market. Many of us hoped it will be crypto. We hoped, the digital gold, Bitcoin, will always move in the opposite direction to the general market. Yet recently we learned that bitcoin could fall from the sky like it did on the 12 March down to 3’670 USD echoing the price movement of all other financial assets.
Looking at the price development of Bitcoin in the last 10 days, to me it looks like high level of volatility is here to stay. Will bitcoin surge back to 20’000 USD or more, supported by further money printing, collapse of the banking system or halving event? Or will it keep crashing like last week over and over again? Nobody knows for sure. But one thing is clear – in the time of crises, in case you must depend on this money one day, holding too much in crypto is not advisable. Even for me, as an outright Bitcoin maximalist, holding the majority of saving in cryptocurrency, now is the time to hedge.
But what this hedge could look like? If it is not US dollar and real estate what else is out there for us? The natural answer is – gold. But where is it heading right now? Let’s look at the historic correlation between gold and the stock market. In the time of crisis, it tends to be negative, meaning that gold’s price rises as stock markets fall. Through wars and the worst recessions — including the 1930s Great Depression — we have experienced a massive rise in the price of gold. During the last two recessions of 2000 and 2008 gold protected the portfolios of investors like no other asset. During the Global Financial Crisis, gold’s price grew by more than 200% soaring from USD 850/oz in 2008 to USD 1’800 /oz in 2011. This is why gold is generally referred as a safe-haven asset or chaos hedge.
Why now is a good time?
The stock market collapse over the last two weeks, in which S&P 500 slipped around 30%, with further losses likely, has yet to see its counterbalance in a rise in gold’s price. But why hasn’t this happened yet? The reason is that during the initial stage of a stock market crash, market participants need to unbundle leveraged positions, liquidating — among other assets — their gold positions. This is the reason that gold has so far not reflected the fast switch into recession already visible in the real economy and stock markets. The price is flat on the year-to-date basis, hovering at around USD 1’500/oz at the time of writing.
Another metric, the total holdings of gold, reveals that investors have been preparing for a shift in the economic cycle for a while now. The total holdings of bullion-backed exchange-traded ETFs are at the record high, having doubled from 1’450 to 2’700 tons during the last four years, according to Bloomberg.
Lastly, there is a rather inverse relationship between the value of the US dollar and gold. The US dollar lost 93% of its value over the last 100 years. And this journey is long from over. Looking at the massive USD 23 trillion national debt and the recent monetary policy decision by the US Federal Reserve, one can expect further devaluation of the greenback in the near future. As a matter of fact, this week, the US Federal Reserve decided to lower the benchmark interest rate from 0.25% to 0% and relaunched its quantitative easing program with initially 700 trillion US dollars.
The fundamental role of blockchain
Many experts in the cryptocurrency space hoped that the first cryptocurrency, Bitcoin, would turn into some kind of digital gold, the safe-haven asset negatively correlated to the overall economy. Unfortunately, that theory has not played out this time and the price of the Bitcoin plunged in line with the overall stock market going from USD 8’000 to USD 3’670 during the last week. The liquidity crunch and the leverage are partially to blame. But the crucial role of the blockchain during this crisis might have nothing to do with Bitcoin, and rather be more on the side of tokenization of real assets.
Today, the predominant way to get gold exposure is through physical gold-backed exchange traded funds (ETFs). To invest in these ETFs, you either need to have an account in the bank that offers such instruments or open an account on a trading platform offering gold ETFs. This is the old world. Decentralized finance does away with barriers like these.
First let’s have a look at the way in which physical gold ETFs and tokenized gold are similar. Both represent ownership rights in physical gold stored at some secure vault. Also, both can be traded on exchanges and represent a relatively liquid asset. The difference between ETF and tokenized gold is that a trader can sent the token globally, peer-to-peer, in a few minutes to anybody anywhere who has a blockchain address. No bank account necessary. The result is that this tokenized gold can be used not only as a store of value but also as a means of payment, whereas it can travel completely outside of the banking system. It becomes the type of money we used before Bretton Woods did away with the gold standard. It might be even the money the world will turn to again, should state defaults and bank runs become daily news.
While governments are looking at ways of tokenizing their national currencies and companies like Facebook working on digital corporate money, all of this might come too late. The world in crises will need a fast and reliable transfer mechanism for stable money that everyone trusts. This is how the global financial crisis might become that catalyst that catapults blockchain-based digital assets such as tokenized gold to mass adoption.
For this to happen we need three things: token issuers, exchanges and trust. The role of token issuers is to reliably put appropriate amount of precious metal behind each token issued. The role of exchanges is to enable trade and provide liquidity. The representative of the first group — Paxos, was an early pioneer, issuing the gold-backed PAXG token, which is today the only fully regulated gold token that you can redeem for LBMA, accredited Good Delivery gold bullion bars. On the exchange side, PAXG has been introduced at several venues. The recent addition is Switzerland-based SMART VALOR. Last week it became the first European crypto exchange to embrace PAXG and enable direct on-ramps and trading in Swiss Franc, GPB and EUR via bank wire or credit card payment.
The third component – trust – will be the one which is the hardest to achieve. In the eyes of traditional investors crypto exchanges are not the place of trust. You could see this as last week the streets of many European cities were filled with people queueing in from of Degussa gold shops. They clearly do not trust their banks to hold that gold ETF for them. No need to mention token or digitalized gold ownership. But to many of us in the crypto space things look different. We trust decentralized networks; we trust the technology. Therefore, for the gold on the blockchain, it is us who will be the early adopters - this time again.
Disclaimer: Cryptocurrencies can fluctuate widely in prices and are therefore not appropriate for all investors. Past performance does not guarantee future results. This is not a financial advise.