How will Bitcoin react to the next recession?
Bitcoin was birthed after the 2007–2008 Global Financial Crisis. The erosion of trust in the government alone was enough to propel bitcoin to adoption. As economies around the world are faced with the threat of another recession, a lingering question in every crypto enthusiasts’ mind would be,
“Will Bitcoin survive a recession?” or “What will happen to bitcoin in a recession?”
This article aims to answer that question by taking a look at the facts and making healthy assumptions since Bitcoin hasn’t been through an actual recession.
Bitcoin: The Digital Gold
The properties of Bitcoin is why it has been named as Digital gold. Bitcoin’s hard cap makes it scarce, like gold, hence, there can only ever be 21 million BTCs. It needs to be minted by spending energy, just like gold, and it cannot be minted at a faster rate at the expense of more energy.
Due to all these factors and more, the stock-to-flow (S2F/SF) model of Bitcoin closely resembles that of gold.
SF, put simply, is the ratio of existing stockpiles or reserves to the yearly production. The higher this ratio is, the better an asset is at being a store of value. Store value becomes important during times of economic/financial crisis when cash or fiat money loses its value and purchasing power due to inflation. Hence, gold, which has a high SF ratio is considered as a safe-haven asset and is used as a hedge against times of economic distrust and crises.
An anonymous Twitter user with the screen name “PlanB” is famous for his SF model on Bitcoin. The attached chart compares the SF of Bitcoin with Gold and Silver.
PlanB stated in his post;
“The dominant driving factor (among gold, silver, and Bitcoin) seems to be scarcity / SF. What is very interesting is that gold and silver, which are totally different markets, are in line with the bitcoin model values for SF.”
It can be noted that during the peak of the 2017 bull run, the total market value of Bitcoin hit $230 billion, which was very close to that of Silver.
With the current supply of 18.29 million BTC and a production rate of 6.5 million BTC per year, the SF value of Bitcoin is 30.
The attached table shows that the current SF value of Gold is the highest, following this is Bitcoin and Silver.
Since similarities between Bitcoin and gold are established, it is time to take a look at how gold reacted during the 2008 financial crisis.
Gold and the Great Recession
During the 2008 financial crisis, the gold prices plunged by almost $300 from $1000 to $700 and the reason for this was, in part, liquidity shortage in the credit market.
However, after the crisis, the price rallied to new highs due to the intervention of the government and the injection of liquidity through various quantitative easing and fiscal stimulus methods.
In general, this infographic shows how things play out during a crisis. The crisis causes panic and a huge sell-off in the financial markets, which leads to a shortage of dollars (cash).
Since dollars are in short supply and there is a higher demand, the value of dollar appreciates, this, in turn, causes forced sell-off of assets like gold causing a depreciation of gold in terms of dollars.
During this time, the market is completely dry and void of liquidity. So, the government needs to intervene and ease the pain with fiscal stimulus. Similar to what happened in 2008 and what’s happening in 2020. The Federal Reserve Bank prints money to bail out essential institutions by lending dollars.
Since there are more dollars in the economy now, there will be eventual inflation in the price of the dollar causing appreciation of gold.
More precisely, in 2008, the banks’ last line of defense was mortgage-backed securities and ineligible collaterals. The latter was used to get gold from the bullion banks, which were eventually sold on the open market to get cash. This created an extreme selling pressure, pushing the price of gold lower.
Bad debt was bought by the Fed during the Quantitative Easing (QE), which cushioned the collapse of the stock market.
The takeaway from this is that the gold markets act as a liquidity provider or the penultimate resort, while the Fed is the ultimate/last resort.
What does this have to do with Bitcoin?
In the recent Bitcoin sell-off, which has come to be known as ‘Black Thursday’, Bitcoin faced a pressure similar to that seen in 2008.
Due to a multitude of events like the OPEC+ deal falling apart and the impact of COVID causing widespread panic across the U.S. stock markets, causing the DJIA and S&P500 to suffer the steepest collapse in the history of the stock markets.
This collapse can be pointed to the institutional buyers getting out of positions that were anything but risky. This involved cashing out of the equities market and the cryptocurrency market.
The proof for this can be found in the Open Interest of the two main institutional service providers in the cryptocurrency ecosystem, Bakkt, and CME.
The same was observed across all Bitcoin markets, spot, futures, and even options. Although the recent sell-off was due to a massive correlation between S&P500 and the Bitcoin markets and this was due to the investment of institutional money in Bitcoin.
So, what will happen to Bitcoin if 2020 turns out to be a recession?
Bitcoin and the “2020 Recession”
Bitcoin would react exactly the same way gold did in 2020, especially, if the OI from these institutional players continues to rise. Although the recent sell-off was due to the institutional exit, this created a retail panic causing the sell-off to be extended.
However, the stock markets seem to be responding well to the $6 trillion stimulus package, but when they stop reacting and start dipping, Bitcoin will plunge with it, especially, if the institutional money flows into Bitcoin again.
Originally published at https://www.gda.fund on April 1, 2020.