Bitcoin correlates with stocks, so how will it perform in a recession?

Is Bitcoin on the road to short-term disaster, long-term success or both?

One of the great things about the ever-growing potential for a recession amid the bloodbath that coronavirus and the oil price wars are currently inflicting on the global economy, if you're a silver lining type of person, is that these circumstances present a very clear picture of how Bitcoin actually performs in times of trouble.

This has proven to be a valuable opportunity because Bitcoin in practice has been almost the polar opposite of Bitcoin on paper.

Bitcoin on paper

In theory, one of the main narratives around Bitcoin is that it's a safe haven. The other is that even if it's not a safe haven per se, it's still similar as a rare example of an asset class that's theoretically meant to be completely uncorrelated to traditional markets.

That's not what we're seeing though. Instead, we have Bitcoin and the stock markets dancing a duet. It appears to be an interpretive dance about the economic impacts of coronavirus.

Source: The Block

Also per The Block, CME Bitcoin futures just saw their lowest volume of the year right as the stock markets are dropping. Their all-time high volumes also happened just the day before US equities made all-time highs on 19 February.

Basically, it looks like Bitcoin is just carpooling with the stock markets. They're going the same place at the same time. The current correlation is impossible to ignore. One of the big questions this raises now, with the prospect of a recession looming, is whether this trend will continue.

If the stock markets are about to take some more massive hits, and if Bitcoin is mirroring the stock markets and if altcoins are mirroring Bitcoin, does that mean the cryptocurrency markets are about to get utterly decimated by coronavirus?

Let's unpack the two schools of thought here, starting with the reasons why cryptocurrency is doomed and you'd have to be crazy to give it a second thought.

Why cryptocurrency could fail during a recession

Bitcoin will fail because we can clearly see Bitcoin mimicking equities, and it's hard to see why that trend would suddenly stop. Obviously, Bitcoin is a risk asset, and people are unloading it in times of stress.

Consumers also tighten their belts during a recession, and it's really hard to imagine anyone thinking it's a good idea to splurge on cryptocurrency when the going gets tough. When someone goes to the shops to buy bread and milk (or tinned food and ammo), they're not going to just impulse buy a bit of cryptocurrency while they're there.

The likely-impending failure of the Bitcoin halving narrative will just put another nail in the coffin and serve to convince people that the whole Bitcoin experiment was a failure.

Outside of Bitcoin, altcoins could fare even worse. Only a fraction of them are useful in any way, and only a fraction of the useful ones are truly indispensable. Businesses will also be looking to cut costs, and it's likely that any cryptocurrency or blockchain experiments will be shelved for the time being.

"Outside of BTC and ETH, I’d expect a late 2018 caliber bloodbath. Nothing else is critical to own or hold right now outside of these two assets, and in a market that may go down 20, 30, 40%, with an unknowable negative human toll (both health and economic wellbeing), the parlor games of the shitcoin casino are over," predicts Messari's Ryan Selkis. "Crypto assets with strong fundamentals will finally have their day in the sun, and we’ll see the decoupling of good and weak projects."

Why cryptocurrency could succeed during a recession

A counter-argument is that Bitcoin's current habit of rollicking along as a risk asset doesn't invalidate its potential as a safe haven. Even gold, which is often perceived as the ultimate safe-haven asset, doesn't just uniformly do the exact opposite of whatever the stock markets are doing.

It's not quite that simple.

We can see that gold actually fell quite dramatically and consistently as the GFC struck in 2007-2008.

GOLD chart by TradingView

This is because people liquidated gold to cover debts and other positions as the markets crumbled.

Bitcoin didn't exist in 2007, but today one could arguably point at Bitcoin's tight correlation with the stock markets as the incidental result of people liquidating Bitcoin to pay debts elsewhere in a falling market – exactly as they did with gold in 2007.

As we can see, after the initial drop in 2007, gold bottomed out ahead of equities in 2008, and then went on a tear. It continued ascending even as the markets recovered. In fact, it only plummeted again in 2012, when the Federal Reserve announced that it was ending its stimulus program.

In other words, it looks like most of gold's price rise was precipitated by the central bank stimulus program, rather than just the state of the stock markets.

In other other words, safe havens are more about retaining value than making money. They're meant to hedge against inflation and concerns about fiat currency stability, rather than just countering stock markets. This is well in line with Bitcoin's original value proposition.

From one angle, someone can look at Bitcoin right now and predict near-term disaster for the cryptocurrency markets in a recession, with a reasonable degree of confidence. From another, someone can look at the exact same situation and say Bitcoin is doing exactly what a safe haven should do.

When the rubber meets the road, Bitcoin's prospects of success as a new digital gold could be based on whether it can practically outperform gold as a useful store of value. As enlightening as the last few weeks have been for Bitcoin, it's still too soon to say whether it'll go the distance.

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Disclosure: The author holds BNB and BTC at the time of writing.

Picture: Shutterstock