Bitcoin Is Having A “Told-You-So” Moment

The cascade of banking worries that kicked off with the collapse of Silicon Valley Bank (SVB) has rocked all kinds of financial assets. But not bitcoin: it just had its best week since January 2021. With antibank sentiment rising once again around the world, the OG crypto is taking this moment to gloat. After all, antibank notions are this asset’s very DNA. So, let’s take a look at why you might want to own some bitcoin now, and why you might not want to get in too deep.

Wait, why exactly is bitcoin rallying?

Well, a few reasons. For starters, bitcoin is benefitting from the growing mistrust in banks. The SVB failure (and problems at other financial institutions) made people realize that the money they’ve been depositing at banks isn’t so much their money in the way they’ve always thought, but rather a loan to the bank. And they’re realizing that banks do lots of things with their money, like using it to make loans to other customers (because under the fractional reserve system, banks have to keep only a fraction of deposits in their reserves) or investing in yielding assets like bonds. And if the bank fails – say, because all the depositors want to withdraw their money at the same time and the bank lacks the liquidity – they might not recover all their savings (although the Federal Deposit Insurance Corporation, or FDIC, insures the first $250,000).

Bitcoin, on the other hand, is decentralized (meaning, it’s not controlled by any authority or intermediary), transparent (all transactions are recorded on the public blockchain), and portable (it can be transferred across borders and platforms). And if you hold BTC in a private wallet, you’re shielded from counterparty risk. Bitcoin, then, provides an alternative (although not without its own shortcomings) to the traditional financial system.

Bitcoin is also benefiting from macro tailwinds. Unlike cash, which can be printed at scale, bitcoin’s new supply is programmed to shrink, which makes it less likely to be devalued by future money printing or manipulation by central banks. So when investors anticipate that central banks might unleash new stimulus, like slashing interest rates or launching huge-scale asset purchases, bitcoin becomes more attractive versus traditional, “fiat” currencies. Put more simply, like gold and Treasury bonds, bitcoin benefits strongly from falling interest rates and increased liquidity, which explains why all three assets performed so strongly since SVB’s collapse.

Finally, bitcoin has likely been benefiting from technical factors. There’s been evidence of a short squeeze, which happens when prices rise and short-sellers (i.e. investors betting that the price will fall) are forced to close their positions, which creates additional buying pressure and continues the cycle. Bitcoin may also have benefited from flows from stablecoins being converted to bitcoin.

So, should you load up on bitcoin in this environment?

Let’s face it, bitcoin isn’t just a speculative asset anymore. It provides an alternative to the traditional banking system, and a hedge against the unintended consequences of extreme fiscal and monetary policies – which could become increasingly likely as pressures on the financial system grow. As a result, it may make a lot of sense to hold some bitcoin in your portfolio.

That being said, you need to understand the risks and limitations of bitcoin, particularly as it relates to its role as a hedge in the current environment. So here’s why it may make sense to hold only some bitcoin, rather than going all-in on the OG cryptocurrency.

First, bitcoin is a good hedge against hyperinflation, but not necessarily against all types of inflation. For instance, bitcoin isn’t likely to work well as a hedge against cost-push inflation (i.e. an increase in price due to external shocks, like supply chain disruptions). Its performance last year also showed that it isn’t a great hedge against inflation when it’s merely high but not extreme.

Second, bitcoin isn’t a reliable safe-haven asset – i.e. one that’s likely to preserve its value during times of market turmoil. Bitcoin may do well in some extreme scenarios, but it’s unlikely to perform strongly if investors opt to de-risk their portfolios. True, it’s not just a speculative asset anymore, but as long as it can’t be widely used as a means of payment, it still relies on investors being willing to take risks. And its correlation to other assets has been highly unstable, meaning you won’t really know for sure how it’ll behave in different scenarios.

Third, bitcoin is a long-duration asset. So it thrives when interest rates are falling and liquidity is being added to the system, but suffers when interest rates are rising or when financial conditions are tightening. Should the Fed be forced to hike rates higher, or keep them high for longer, bitcoin is likely to disappoint.

Fourth, bitcoin prices remain extremely volatile, making it a less-than-ideal store of value, particularly if you need the liquidity over the short term. That’s something you might want to consider before forking over your savings. On the bright side, its paciness can also mean you could go a long way with a small position.

Fifth, unless you hold bitcoin in a private wallet, where you have access to your own private keys, it’s not your bitcoin. In fact, if you buy bitcoins through an exchange, you’re even less protected than if you held it at a bank. So if you do want to buy some bitcoin, make sure you do it the right way. Keep in mind the bitcoin saying: “not your keys, not your coins”.

Sixth, bitcoin mightn’t be as decentralized as you’d think. Mining power is concentrated among a few large mining pools and some aspects of its operations include cloud-based services (and so, they rely on a few providers like Amazon).

Seventh, bitcoin isn’t as isolated from the traditional banking system as you’d hope. Sure, the network can operate without banks, but it continues to be influenced by central bank policy and needs banks to facilitate the movement of funds into bitcoin. This is why bitcoin hasn’t always rallied with bank uncertainty.

Holding some bitcoin could certainly add some balance to your portfolio and protect it in some extreme scenarios. But it’s by no means invincible. In other words, don’t go all-in on bitcoin, and if you’re thinking about hedging some of the risks around the financial system, consider putting other hedges in place too: gold (which is less exposed to financial conditions), US dollars (which may benefit from a tightening of financial conditions and higher rates), and Treasury bonds (in case of a sharp selloff of risk assets).