It has been about a decade since 2008, and we can still feel the aftermath of the financial crisis. Money market funds were considered safe havens for cash, because of their value normally does not fluctuate with markets conditions. However in September 2008, Reserve Primary Fund broke the buck and panicked investors withdrew more than 100 billion from money market accounts where business keep cash to fund day-to-day operations. Investors now worry about whether a financial crisis could happen again. What should investors do to prepare for the crisis? We shall argue that cryptocurrencies are a good store of value, for people during a financial crisis, and a better alternative to gold.
2008 Financial Crisis
Traditionally, several methods can reduce your loss in the recession or financial crisis. For instance, an investor could move its savings from the equity market, and invest in money market instruments like CDs (Certificate of deposit), because they typically fluctuate less with the market. The second method is to buy gold as gold price is stable relative to inflation. When the financial crisis happened, consumers started to panic. They tried to protect their assets and reduce the loss, but it only accelerated the crisis. People do not lose their confidence in gold, they believe in the store value of gold. After the 2008 financial crisis, the nominal gold price against the annualized U.S. CPI (consumer price index) ran up to a new record high.
Though gold is a great inflation hedge, there are storage costs associated with its possession. An alternative is to invest in the cryptocurrency Bitcoin, which is considered digital gold. Bitcoin is free to trade in any currency and it is relatively easy to store. When the traditional markets suffer during the crisis, the cryptocurrency might be a haven for these investors that exposed to the crisis. However, the prices of cryptocurrencies are unaffected by currency crashes. When we compare gold and bitcoin as a safe haven, Bitcoin has the liquidity advantage.
Use of cryptocurrency in Zimbabwe
During a crisis, banks face liquidity risk, and people become uncertain about the future. As a result, the latter invest in commodities, like gold, thus raising its price. Also, during a crisis, interest rates tend to rise, as well as inflation. The situation like this makes loans from banks very difficult to get.
The question is what will happen to a cryptocurrency like bitcoin during a financial crisis. An advantage of the cryptocurrency is that it can be bought from virtually everywhere. Every trade is made online, which makes it easier for both parties. Besides, a cryptocurrency does not require a storage place, compared to gold. When people start taking out money from banks during the crisis, they will look for a safe way to store it. The little effort required to get a cryptocurrency, and the little to no storage cost, makes it more attractive than gold. As a result, the value of a cryptocurrency during a crisis is likely to rise. Let’s look at how two countries, both struggling with hyperinflation, are using cryptocurrency to reduce inflation, and slowly raise their economy.
The Zimbabwean dollar had virtually no value, mainly because of overprinting of the money. Because of inflation was losing value every day, making bank deposits less valuable every day. As a result, Zimbabweans could not withdraw money from banks, as there was not enough of it. Banks also limited the number of withdrawals from ATMs. In 2009, the country decided to stop printing their local currency. Instead, the Zimbabwean central bank issued a 100 trillion notes for the US dollar. The US dollar became the main currency used in the country. Seven years later, the country is facing a trade deficit. Because of the big crisis, Zimbabwe was facing, there was little the country could export. Zimbabwe imported goods, more than they exported. Therefore, the country started to run out of the US dollar. Today, Zimbabweans are now looking for anything that might retain value.
Golix is an exchange created in Zimbabwe, where people can buy and sell cryptocurrencies such as bitcoin. According to the representative of Golix Yeukei Kasangaya, Zimbabweans are using bitcoin in order to access international markets. For example, a local engineer, wanting to buy software outside of the country, can use bitcoin, instead if the local currency. Also, sending money to families outside the country is hard with a currency shortage. As a result, Zimbabweans invest their savings in bitcoin and send some to families in foreign countries. Bitcoin becomes a safe-haven. Instead of depositing $500 in the bank, that will lose value; the population can invest in bitcoins. With Cryptocurrency, Zimbabweans can avoid the need to seek foreign currency from the bank to buy goods. They can instead buy directly from the growing number of merchants that accept the digital currency. The graph below shows the reaction of bitcoin during the financial crisis in Zimbabwe. We observe that as inflation rises, the value of bitcoin also rises. In addition, Bitcoin prices tend to decrease, as inflation falls. We can conclude from this graph that as the value of the Zimbabwean dollar falls, people tend to invest in Bitcoin, which increases its value.
Use of cryptocurrency in Venezuela
Venezuela suffered a similar crisis to Zimbabwe. The country faced hyperinflation, and the bolivar almost all its value. The crisis is mainly due to the billions of loans from other countries, and venezuela’s dependence on seiling oil abroad. From 2014 to 2016, the price of a barrel of oil went from $100 to $26. In other words, Venezuela’s main source of revenue was now about a fourth of what is used to be. With Venezuela running out of cash, and the low price of oil, the government started printing more money. As a result, the bolivar’s value plunged and unemployment started to rise. Having the world’s largest oil reserves, the cash strapped country decided to create a cryptocurrency backed by oil.
Venezuela has plans to offer a cryptocurrency called Petro to the market. One Petro coin will be equal to a barrel of oil. With Petro, the country plans to make financial transactions, while avoiding US sanctions. With the creation of Petro, Venezuela has the opportunity another for financial transactions. Because of hyperinflation, the Bolivar has little value compared to the dollar. As a result, foreign investors have started buying less oil from the country. With Petro, foreign investors will use either the US Dollar, or the Euro to purchase the cryptocurrency. After the purchase, they will be able to redeem the coin for oil.
The graph below describes the reaction of Bitcoin during the crisis in Venezuela. We observe the same movements as with Zimbabwe; the value of Bitcoin tend to increase when inflation is rising. Though Venezuela opted to create a new cryptocurrency to fix their economy, we can assume that the Petro will have a similar reaction as Bitcoin. The minimal storage cost needed, and the easy access to cryptocurrency, make them very attractive to people looking for a safe haven during a crisis.
Bitcoin was originally created in response to the 2008 global crisis. With the emergence of cryptocurrency, people now have more options to protect their assets. After the success of Bitcoin, other digital currencies like Dash, Litecoin, Etherium among many others started to emerge. Zimbabwe and Venezuela are the first countries turning towards cryptocurrency in order to save their economy. However, they may not be the last. Should the United States face another crisis in the future, people will be able to protect their assets by investing in cryptocurrency. Since it behaves like gold, we can expect the value to spike upward. Finally, the unique features of cryptocurrency like the decentralized system, low storage cost, privacy and safety, make it a better option for people to use as a hedge against inflation.
- With Barry Cai, Yusef Hashem
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.