Bitcoin: The Unexpected Adult in the Crisis Room

Few financial assets have been as stable as Bitcoin (BTC) recently. Over the past three months, the price of the cryptocurrency has hovered close to $20,000 with little deviation.

During the same period, traditional asset classes have been significantly more volatile:

• Large cap stocks, measured by SPDR S&P 500 ETF Trust (SPY), fell 16% from mid-August to mid-October.
• Bonds with investment grade, measured by iShares 20+ Year Treasury Bond ETF (TLT), has fallen 19% over the past three months.
• Gold, measured by wood SPDR Gold Shares The ETF (GLD) is down nearly 10% since the beginning of August.

During the first half of this year, Bitcoin investors took a beating. After peaking above $47,000 in late March, the price of one Bitcoin fell below $20,000 in late June.

But since then, Bitcoin has been a model of consistency. While stocks and bonds have swooned wildly in response to monthly inflation reports and subsequent Fed rate hikes, Bitcoin has barely reacted at all.

It’s not because investors have lost interest in Bitcoin. In fact, the average daily trading volume for Bitcoin was slightly higher in October than in January. Still, over the past six weeks, the price of Bitcoin has fallen less than 5% from the $20,000 mark.

I find that last data point fascinating. If speculators are still trading Bitcoin, the price should be more volatile.

It makes me think that Bitcoin is now being used for a different purpose. Namely as a store of value until the Federal Reserve has finished raising interest rates and the bond market stabilizes.

Who looks after the shop?

If the main purpose of Bitcoin has changed from speculation to capital preservation, it begs the question: Who is now using the cryptocurrency for that reason, and why?

It certainly isn’t the individual investors who bought Bitcoin last year hoping to double their money overnight. Most of them have either been washed out or are waiting for the price to double so they can get out without losing their shirts.

Nor are large companies such as e.g Micro strategy (NSDQ: MSTR) which loaded up on Bitcoin earlier. That strategy has proved disastrous. Since peaking above $700 a year ago, MSTR is now trading below $300.

I also don’t think private equity is behind Bitcoin’s newfound status as a stable asset. Most of this money goes to currency bets on the US dollar, which has risen in value this year.

My guess is that it is institutional bond investors who are now using Bitcoin for capital preservation. When interest rates go up, the value of fixed-rate bonds goes down. Right now, many of these investors have large losses in their bond portfolios this year.

It creates a dilemma. Should they reinvest the cash flows they receive from their current holdings in newly issued bonds at higher yields, understanding that these bonds may soon lose value as interest rates rise?

Certainly, last week’s 75 basis point increase in the Fed Funds overnight rate didn’t help, especially after Fed Chair Jerome Powell indicated that he may be far from done raising rates to bring down inflation.

Upside down

It is not clear how much longer or higher the Fed will continue to raise interest rates. For that reason, bondholders may prefer to reinvest the interest and redemption payments they receive in a stable asset.

However, they would rather not compete with private equity investors for dollar-denominated securities right now. When that game is over, those investments could crash hard as everyone runs for the exits.

Consider Invesco DB US Dollar Index Bullish Fund (UUP). Through last week, UUP was up 17% this year.

According to UUP’s sponsor, “This ETF offers exposure to a basket of currencies relative to the US dollar, which declines in value when the trade-weighted basket strengthens and increases when the dollar appreciates.”

It is only a matter of time before the dollar begins to weaken. And when it does, this fund can just as quickly return the year’s rapid gains.

If you want to bet on a big drop in the dollar next year, one way to do it is to buy a put option on the UUP. A put option increases in value when the price of the underlying security falls.

For example, last week while UUP was trading just above $30, the put option expiring in January 2024 at that strike price could be bought for $1.60. For the trade to be profitable, UUP must fall by more than 5% over the next fourteen months.

It is clear that Wall Street does not believe that the dollar will fall anytime soon. However, it wasn’t that long ago that it didn’t think Bitcoin could collapse, either.

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