Dr. Raffael Huber

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Cryptocurrency markets have recovered strongly from the drop in mid-March that saw a low of around $3.6k for Bitcoin. Bitcoin almost reached $7k and is now consolidating around $6k. On a fundamental level, advances for major blockchains keep continuing. The specifications of Ethereum 2 have passed the audit by security firm LeastAuthority, with few potential vulnerabilities to still address. In addition, the Baseline Protocol – a joint effort by ConsenSys, Microsoft and EY to use the public Ethereum chain for confidential on-chain collaboration between enterprises – has been open-sourced on GitHub. The Bitcoin block reward halving is now less than one and a half months away and is projected to take place on May 13, 2020, with the block reward halvings on Bitcoin Cash (BCH) and Bitcoin Satoshi Vision (BSV) happening even sooner – in approximately 8 and 10 days, respectively.
However, during a time like this, it is also important to keep global macroeconomic events on the radar. As mentioned in the last episode of Decrypt, Satoshi Nakamoto’s vision for Bitcoin included the idea of it being a way out of currencies that require trust. The trust in conventional fiat currencies may now be put to the test rather sooner than later.
Traditional markets have continued to experience pressure due to the pandemic and global economic crisis. For example, initial jobless claims in the U.S. rose above 3 million, which represents an (unfathomably rare!) 30-sigma event, statistically speaking. Governments and central banks all around the world are unleashing their fiscal and monetary policy firepower to counteract the consequences of the pandemic on the economy, with the goal to ensure liquidity in the financial system and support the flow of credit.

 

Massive Stimulus Packages
In that regard, a swathe of measures have been put in place globally. The Federal Reserve has dropped interest rates to 0% and announced a first immediate help package to the tune of $700 billion, purchasing $500 billion of Treasury securities as well as $200 billion of mortgage-backed securities. The reserve requirements for banks and other depository institutions have been lowered to zero percent, which allows them to accelerate the expansion of credit. Later, the Fed announced for the first time that it would purchase these securities “in the amounts needed” – equaling the announcement of unlimited quantitative easing (QE). Its balance sheet has since grown from $4.2 trillion to $5.2 trillion over the course of a month (or: by about $400k per second).

Illustration 1: The balance sheet of the Federal Reserve has continuously grown since 2008, and spiked in the past month from $4.2 trillion to $5.2 trillion.
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Source: federalreserve.gov, Bitcoin Suisse Research.

On top of that, the U.S. Congress has passed a $2 trillion stimulus bill, which includes a direct payment of $1’200 to each individual and direct support to all parts of the economy. The original version of this bill also included talk of a digital dollar, which has been removed in the final version though. Nonetheless, this has reignited discussions about central bank digital currencies.
Other central banks have taken measures of similar relative magnitude. The Bank of England has launched an initiative to buy unlimited quantities of commercial paper. The European Central Bank has announced a €750 billion “Pandemic Emergency Purchase Programme”, and lifted its restriction not to buy more than one-third of a country’s eligible bonds. This is in part done to provide ample liquidity to countries that now plan to ramp up their spending, which in turn will come with rising debt levels. These rising debt levels put central banks and governments in a difficult position: They will need to continue to help debtors rather than creditors to keep the house of cards of ballooning debt as stable as possible. As such, interest rates can be expected to remain low, or debt will need to be monetized by central banks – which in turn could shatter the trust in the currency that this debt was issued in.

  • There is an infinite amount of cash at the Federal Reserve. We will do whatever we need to do to make sure there is enough cash in the banking system.
    – Neel Kashkari, Federal Reserve Bank of Minneapolis

How Does All This Relate to Cryptocurrencies?
Cryptocurrencies were invented as a form of money that does not require trust in a central authority, such as a government, not to debase it. The issuance of new cryptocurrency is programmatically defined – for Bitcoin, the issuance schedule converges towards 21 million as a hard maximum, and the majority (or 87%) of that has already been mined. The reason for issuing new coins is solely to ensure the security of the network and incentivize miners.
As such, cryptocurrencies are often seen as an inflation hedge – a safe haven not in the short term, but in the long run to protect against currency debasing. Gold as the classic inflation hedge and safe haven money has recovered from its drop two weeks ago. However, gold markets remained in distress, as supply chain disruptions have caused gold futures to decouple from spot prices (which led the CME to launch new futures contracts with more flexible physical delivery options).

 

Inflation vs. Deflation
Thus, it is crucial to look at both inflationary as well as deflationary pressures that are now present in the markets, especially since previous quantitative easing programs by central banks did not cause a spike in inflation. The consumer price index (CPI), which is one of the most widely watched measures for gauging inflation (alongside the producer price index PPI), has increased steadily by the Fed’s desired range around 2% since the first quantitative easing program was started in the post-2008 financial crisis era. However, previous QE programs did help the stock markets go on a near-unprecedented bull run, indicating that much of the money may have ended up in financial assets. The situation at hand now has eliminated a lot of the wealth generated on paper, and the large negative demand shock due to the pandemic adds to the deflationary forces that counteract the printing presses put in motion by central banks. Also adding to deflation is the large drop in oil prices – oil is a major input cost to the economy, and that cost has been slashed by more than 50% in March.
Overall, the course of the pandemic and global economic crisis will define how inflationary and deflationary pressures compete against each other. In the case where inflation picks up or even goes into hyperinflationary overdrive, cryptocurrencies offer one of the few ways out of traditional fiat currencies and into an easily transferrable, hard money that is resistant to debasing.