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Can inflation, geopolitical events, or a country in crisis be beneficial to cryptocurrencies?
As Bitcoin continues its ascent, taking back three-eighths of its decline from the December 2017 highs, the 95%, the inconsistent majority enter late out of position and with no concept of risk.
While the majority scour social media and sites looking for articles that support their opinion, the 5% patiently wait for moments in time where risk and reward can be quantified, and information can be gained if their position idea fails.
Most cryptocurrency traders take their cues from others and trade off the technicals, using indicators like the MACD, RSI, and moving averages as their sole reason for taking the trade, not realising these momentum indicators are all just different ways of confirming the same thing.
The 5% use technicals when trading only over the short term timeframes, or as a trigger for entry into a position they expect to hold for a longer period.
Entering into a long term hold and building a campaign works best when background conditions are favorable. In the commodity markets, one method used as a short cut to confirming favorable conditions is backwardation and contango.
Usually, a commodity will be more expensive the further out in time the expiry date. This is called contango. Sometimes, when the supply of a commodity is expected to become bottlenecked, the prices of the near term contracts start trading at higher prices than the longer-dated contracts. This state is called backwardation, and when a market transitions from contango into backwardation, the market move, if it starts, has a higher likelihood of being for real.
Commodity markets also have open interest, as well as volume, to help evaluate the underlying conditions.
Contango, backwardation, and open interest are direct market feedback indicators generated internally by the underlying supply and demand, but sometimes the causes of favorable conditions aren’t market generated; they are exogenous to the market but affect the supply and demand.
While the social media buzz is talking up Bitcoin and the top alt-coins, causing the 95% sitting on the fence to throw in the towel and enter, the 5% study geopolitics and other external variables that could act as a long term favorable condition for their trading ideas.
It’s easy to act in your best interests when times are good, but what about when life throws you a curveball?
If you were born on the right side of the fence, life is relatively easy. But what if you weren’t?
Since the end of the Second World War, life in the West has been stable and safe compared to other parts of the world.
The lights come on when you turn on the switch, the shelves in the shops are full, and employment, if you’re willing to do anything, is nearly always available.
But, even in the West, where the quality of life and longevity has improved, despite the 100% increase in the global population, there are times when things go sideways.
Sometimes a local dispute flares up and goes national, other times countries are placed in hardship by an enforced embargo, and sometimes the prices of natural resources balloon out of control as geopolitical events strangulate the supply.
In times of crisis, the little things you take for granted become valuable.
When the lights go out, what is more important — your iPad, or toothpaste?
In a crisis, here are the top ten things that become scarce — fast.
Generators, water filters, portable toilets, seasoned firewood, lamp oil, guns, ammunition, knives, and baseball bats.
After these items, it is the staples.
Can openers, whisks, honey, sugar, rice, beans, and wheat.
And in 2019, you can add another commodity to this list — Bitcoin.
In the Parabolica series of articles, podcasts, and videos, we discussed how the invention of the bond market during the Italian renaissance changed the way money works. The TLDR version is this: Bonds are the price you pay for risk.
When the underlying trust in a government’s ability to pay back its debt erodes, the higher the return that is demanded by the bond buyers because of the increased risk of not being paid back.
In recent history, countries like Argentina, Zimbabwe, and now Venezuela have suffered the effects of what happens when trust in a country’s government and underlying economy evaporates.
As trust decreases, the returns demanded by investors to purchase the struggling country’s debt increases, and, if this gets out of control, the price of bonds plunge as the yield on the bonds soar. And this sets up conditions of the onset of hyperinflation.
In April 2019 the rate of inflation in Venezuela is running at 282,973%, according to the International Monetary Fund.
Or, put another way, an item costing $350 one year ago, would cost $1,000,000 today.
And this causes the total and complete destruction of wealth.
In February 2019, the Venezuelan government launched the Petro, a government-backed cryptocurrency backed by Venezuela’s natural resource reserves.
But the Petro has been largely ignored by the Venezuelan public because of the lack of trust in the Maduro government.
So how did an economy rich in natural resources, once the wealthiest nation in South America, find itself in this situation?
In 1998, Hugo Chavez won a landslide election with a promise to bring a social revolution to Venezuela proclaiming that the time had come for a rebirth of a people.
At the time, Venezuela was the wealthiest economy in South America with huge oil reserves, but, despite this, half of the population was living in poverty, existing on less than two dollars a day.
Chavez promised to end this situation, and despite criticism from a wide range of agencies, he managed to hold on to power until his death in 2013.
In 2013, Chavez’s chosen successor, Nicolas Maduro, became president. Since Maduro took office, Venezuela has descended into an economic and humanitarian crisis.
The scale of the crisis has forced millions to flee the country, and Maduro has been accused of mismanagement and of running a dictatorial and authoritarian state.
By 2018, more than 80% of the population live in poverty. The shelves are empty, the people are starving — and unrest is beginning to get out of hand.
Thousands took to the streets resulting in violent protests. When Maduro won a second term in office in 2018, the election result was denounced as a fraud.
In January 2019, a relative unknown, Juan Guido, formally assumed the powers of the president of Venezuela, but Maduro refused to step down, having the support of the Venezuelan military.
Meanwhile, the value of the Venezuelan currency, the Bolivar, is being eaten alive by hyperinflation as its value plummets.
As millions flee the country, many more are doing what they can to save their wealth.
When inflation is spiraling out of control, and the banks won’t give you money, how do you protect yourself from the ravages of hyperinflation?
You could buy gold, but gold is heavy and not easily transportable which is an important consideration if you need to leave in a hurry, yes a handful of coins or a few ounces of gold wouldn’t be a problem, but what about the price?
Since 2013 gold priced in US dollars has traded in a range between $1,400 and $1,040 an ounce, but with hyperinflation, the value of a currency is destroyed.
Gold priced in Venezuelan bolivars is currently trading at 7,595,684 bolivars an ounce, up 10,350.88% since September 2018 when gold was trading at 73,382 bolivars per ounce.
Using data from Localbitcoins.com it’s clear Venezuelans are using Bitcoin as a tool to save themselves from an economic abyss.
In mid-May 2019, around 700 Bitcoins per week are being traded, that’s down from over 2,000 in early January 2019. Why the decline? It’s because of the rate of decay of the buying power of the Bolivar.
Again, using Localbitcoins.com data, the amount of bolivars being used to buy and sell Bitcoin is up 400% since the beginning of 2019.
As the Venezuelan government desperately sells its gold reserves to purchase hard currency, and as the value of its currency plummets, causing a mass exodus from the country, can the situation inside the country account for and be counted on for the continued rise in Bitcoin’s price?
The short answer is no, but what the data suggests is that Bitcoin can and is being used as a serious alternative to gold when inflation gets out of control.
Venezuela is not the only country suffering from high levels of inflation.
Argentina and Iran have inflation running at over 50%, and inflation in Turkey is around 20%.
Hyperinflation is defined when the prices of goods and services rise by 50% in a month. When the momentum of price changes accelerates and approaches 50%, you can expect prices to rise more than once a day. For example, a loaf of bread will be selling at one price in the morning and at a higher price in the afternoon.
When prices change more than once a day, the window of time for you to protect your assets from the ravages of hyperinflation is closing rapidly.
While the Venezuelan crisis is not large enough to drive Bitcoin prices on its own, if inflation gets out of control and spreads to other countries, because of trade wars, embargoes, and sanctions, the Venezuelan crisis has shown that cryptocurrencies can be used as a serious alternative to gold and other precious metals.
One country that is large enough to affect cryptocurrency prices is China.
If the Chinese ever need to get out of the Yuan because of a rapid devaluation and into US Dollars, Euros and other hard currencies, cryptocurrency is the obvious choice. Venezuela has set a precedent.
This is the Yuan exchange rate to the US Dollar. When the price is going up, it takes more Yuan to purchase one US dollar, so when the price is going up, it indicates the Yuan is getting weaker against the US dollar.
In the Wonderwall series of articles, podcasts, and videos, we discussed the tensions between the US and China.
The thirty-second version is this: One of the conditions the US wants China to implement is the revaluation of the Yuan to make it less competitive. A cheap currency compared to the US dollar allows China to export deflation into the US; deflation is not the optimal condition because of the amount of debt the US has created. The US wants some inflation to enter into the system. The level of slack in the US is at near twenty-year lows, and low unemployment amplifies the inflationary effect. One way inflation helps the US is that, over time, it considerably reduces the amount of debt.
But inflation comes with a cost. An inflation rate of 2% reduces the purchasing power of a currency by 50% in 35 years, and by 50% again in the next 35 years. This means in an average lifetime, the purchasing power of a currency is reduced by 75%.
Central banks attempt to keep inflation between 2% and 3%. A little too much inflation risks opening Pandora’s box. A little too less and deflation enters into the system.
Why is the 3% inflation ceiling important? It’s because the effects of higher inflation rates aren’t linear. A 3% inflation rate would reduce the purchasing power of a currency over a lifetime by 90% instead of 75% if inflation were at just 2%.
Why is this important, and what has this got to do with cryptocurrencies?
As tensions increase between the US and China, the possibility that China will devalue the Yuan to compensate for the effects of the US trade tariffs increases. As the amount of tariffs and the percentages the US imposes increases, so does the likelihood that China will devalue the Yuan.
And if China does devalue their currency this does have the potential to act as a huge driver of cryptocurrencies. Specifically, store of value cryptocurrency with enough liquidity to absorb high levels of demand.
Cause and Effect
One quirk of the financial markets, including the cryptocurrency markets is that the actual news or result is not as important as the expected news or result.
This is why, when a company reports enormous losses, the price can go up. It’s because it is not the actual loss, but the expected loss the market is focused on. If the actual result is better than expected, the price will go up regardless of the fact the company made a loss.
It’s the same when a company makes huge profits. Sometimes a company can report record-breaking figures, yet the price goes down. It’s because the result was worse than expected.
It’s not only financial results that affect market behaviour but events too. The British pound is trading around 1.26 against the US dollar with the expectation that a hard Brexit from the European Union is becoming more likely.
The actual event does not have to happen to affect the price. It’s the change in the likelihood that drives prices.
And so it is with expectations of a Chinese reaction to US trade tariffs. Although China is unlikely to aggressively devalue the Yuan to neutralise US tariffs, the likelihood of it doing so has increased. And as the likelihood increases, the demand for commodities that will be affected by the devaluation will also increase.
If China did devalue its currency, it would be a shock even though the likelihood has increased. And shocks cause the rapid readjustment of prices — especially in stock markets.
If the expectation of a Yuan devaluation rises, the more likely Chinese citizens will be to protect their cash assets, and one way of doing that is to buy Bitcoin.
As long as the possibility exists, so does the long term positive influence on Bitcoin demand.