What is the hedging significance of Bitcoin?

The discussion about whether Bitcoin (BTC) can truly serve as a safe haven has started again.

The debate began last Saturday, when the cryptocurrency market plunged nearly 10% after Iran's failed missile strike on Gaza, with the price of Bitcoin falling from around $70,000 to below $62,000. On Monday, some insightful articles analyzed the event, such as Jeff John Roberts of Fortune magazine comparing the event to the 17% increase in the price of gold, and Casey Wagner of Blockwork examining the fluctuations in gasoline prices during the Middle East crisis.

Indeed, after the attack, there were more buyers than sellers for oil and gold, and more sellers than buyers for Bitcoin, so the former appreciated and the latter depreciated. However, I have always believed that intraday price fluctuations do not mean much for an asset as volatile as Bitcoin.

To make matters worse, gold prices continue to rise (just as they did after the collapse of Lehman Brothers), while Bitcoin, after a brief rebound on Sunday, has been falling this week and is now down to just over $60,000.

While the looming threat of World War III could keep a lid on Bitcoin’s price, the market seems to be leaning more toward the suggestion that the Federal Reserve may keep interest rates higher for longer because the economy is performing well.

However, when Bitcoin has been behaving more and more like tech stocks in recent years, it seems a bit of an overkill to ask whether it is really a safe haven asset. Before the pandemic, Bitcoin had a low correlation with the S&P 500, so it clearly served as a counter-cyclical asset. The question is, what has changed between then and now? Moreover, what exactly is Bitcoin supposed to hedge? Stocks? Inflation? U.S. Treasuries? Or political unrest? Is Bitcoin an economic safe haven asset for all situations?

There are likely multiple factors at play, including the number of bitcoins in circulation, the number of holders, and the increase in the number of whales. But at some point, the answer is clear: Bitcoin has become institutionalized. As Barron’s reported when the first spot Bitcoin ETF was launched in January:

“Bitcoin volatility has been steadily declining since its launch more than a decade ago. According to Bauer, volatility (measured as a 100-day average of daily price fluctuations) has never exceeded 4.5% since the introduction of bitcoin futures that track the spot token price. Since the launch of the ProShares Bitcoin Strategy ETF (a bitcoin futures fund) in 2021, the metric has never exceeded 3.5%. Over the past year, volatility has remained below 2.6%.”

While geopolitical tensions could keep a lid on bitcoin’s price gains, the market appears to be leaning more toward signals from the Federal Reserve that interest rates will remain higher, likely reflecting a strong economy.

However, in recent years, Bitcoin has behaved more and more like tech stocks, so it is questionable whether Bitcoin is really a safe haven asset. Before the epidemic, Bitcoin had a low correlation with the S&P 500 index, so it could obviously play a counter-cyclical role. The question is, what has changed since then? What risks should Bitcoin hedge? Stocks? Inflation? U.S. Treasuries? Or political unrest? Can Bitcoin become an economic safe haven asset that applies to all situations?

There are multiple factors that may be at play, such as the number of bitcoins in circulation, the number of holders, and the increase in the number of large whales. But in a sense, the answer is already clear, Bitcoin is becoming institutional. Barron's reported when the first spot Bitcoin ETF was launched in January this year:

“Bitcoin volatility has been steadily declining since its launch more than a decade ago. Since the introduction of Bitcoin futures, the measure of volatility (100-day average daily price fluctuation percentage) has never exceeded 4.5%. With some of the spot Bitcoin ETFs launched this year becoming one of the fastest growing financial products, this trend may accelerate. As the barrier to entry into the Bitcoin market decreases and Bitcoin becomes more mainstream, its correlation with stocks may become closer. People who buy Bitcoin and fund managers now also buy S&P 500 index funds, investor behavior psychology is converging.”

In fact, the entire theory of Bitcoin becoming a mainstream payment method is based on the premise that increased Bitcoin adoption will reduce its price volatility, making it a viable medium of exchange. The problem is that this idea is based on the premise that as the broad-based circular Bitcoin economy grows, the fiat currency system will collapse. In other words, Bitcoin should become less volatile and less correlated with other assets. This is Bitcoin's safe-haven function.

This may stem from one of Bitcoin’s fundamental myths, that it is “digital gold.” However, this is a poor analogy. While linking Bitcoin to gold hints at its potential value, it sets false expectations before people truly understand how Bitcoin works.

Calling Bitcoin "digital gold" may be one of the roots of the mixed views we have today. Bitcoin is expected to play many roles at once: a safe haven asset, a store of value, a payment method, a beta investment, a bet on fiat currencies, and, increasingly, a development platform. Everyone wants Bitcoin to be a universal asset, but the reality is that the one thing Bitcoin has been really good at doing over the past decade is absorbing excess liquidity.

To a large extent, we don’t know how Bitcoin would perform if a major crisis occurred. As S&P analysts wrote in a 2023 report on the macroeconomic impact of cryptocurrencies: “Unprecedented quantitative easing by central banks around the world has increased money supply to record levels since 2008/09,” suggesting that Bitcoin’s growth could be due to an increase in money supply.

In the past, Bitcoin was seen by some as a potential safe-haven asset as a substitute for gold due to its price volatility and scarcity. However, in recent years, Bitcoin's market performance has become more and more like technology stocks, raising questions about its safe-haven function.