Cryptocurrencies during times of economic crisis

There are many signs pointing to the imminent arrival of a new economic crisis, but how will cryptocurrencies behave?

If you look at the yield curve, which is commonly regarded by economists as the main predictor of a recession, it has been falling steadily over the past year.

Overall, global markets have been on a downward trend since the beginning of the year, leading many economists to anticipate an imminent economic crisis. On the other hand, economic indicators show a marked slowdown in industrial production and demand, not only in Europe, but also in Asia and the US. 

Trump’s protectionist policies are definitely not helping. As a result, considering that in 2008, at the time of the last major global economic crisis, cryptocurrencies did not yet exist, it may be interesting to understand how they could behave.

The market for cryptocurrencies is in a very promising position. While speculative investments do not tend to perform well during a recession, the potential use of a decentralised digital currency as an alternative to fiat – either as a form of payment or as a store of value – may mean that a recession could actually help push cryptocurrencies into the mainstream, in other words, towards their mass adoption, something that so far has been lagging behind.

This thesis is reinforced by what has happened in the last two years in countries such as Venezuela and Argentina, which have long been struggling with huge problems of hyperinflation and severe recession, and where the adoption of some cryptocurrencies has certainly reached a greater extent than in other countries.

The first half of 2018 was rather interim for the cryptocurrency market. After reaching the all-time high of $20,000 in January, the price of bitcoins fell significantly and reached $3,000. 

Many cryptocurrencies that had risen considerably as a result of the significant gains from bitcoin have now lost up to 90% of their value. Then, just when the first signs of global crisis began to appear in early 2019, bitcoin began to rise again, reaching almost $14,000. 

This is also because, for many, bitcoin can be seen as a safe haven. For instance, Bloomberg analyst Mike McGlone recently wrote that the cryptocurrency is “gaining traction as [a] store-of-value and digital gold”. 

Eidoo has recently issued its own cryptocurrency, Ekon, directly anchored to the price of gold, precisely to make it easier to invest in gold through a token, whose price is 1:1 with the price of one gram of gold.

But this in itself would not necessarily represent a sign of growth for bitcoin. “In a heavy recession environment all assets get sold down, including in the global financial crisis [of 2008], where the gold price was sold down,” says Leigh Travers, CEO of Digital X Limited. 

His thesis is supported by the fact that, between March 2008 and November 2008, the price of gold had fallen from USD 31.633 per kg to USD 23.802. However, in the event of a crisis, gold has always been represented as a safe haven par excellence and, sticking to the initial point, it is no coincidence that in 2019 the most precious metal has been highly appreciated. 

In this respect Bitcoin has many of the characteristics that the precious metal possesses, such as the difficulty of extraction and its scarcity that renders its value sustainable over time. 

Bitcoin was launched in 2009 by Satoshi Nakamoto as a response to the 2008 economic crisis. The first block extracted on the Bitcoin blockchain, called the Genesis block, included the text “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. 

Since blockchain technology is decentralised, cryptocurrencies – especially bitcoin – are outside the control of governments and central banks. In the event that the recession strikes the United States once again, the general public will be able to resort to an alternative solution based on blockchain technology. 

While the government can always print more money and add it to the amount currently in circulation, this is not possible with most cryptocurrencies. Moreover, the prices of cryptocurrencies are exclusively dependent on supply and demand dynamics and are free from government supervision or intervention. 

Although it is impossible to know how exactly an economic crisis can affect global markets, it is reasonable to believe that cryptocurrencies will see greater adoption. 

However, the same possibility does not apply to all of the approximately 1500 cryptocurrencies on the market today. After all, most blockchain startups that issue tokens with an Initial Coin Offering (ICO) do not have a working product even after several months. 

In a declining economy, cryptocurrencies are more likely to be used as an alternative to fiat for payments and savings, not so much as utility tokens for niche blockchain applications.

Bitcoin will probably be the first cryptocurrency the world will turn to simply because this is the only known alternative at the moment. However, at present, the Bitcoin network cannot handle a large influx of transactions. The last time this happened, in December 2017, transaction fees increased to double digits, making small trades impossible. 

Ethereum, Litecoin and Bitcoin Cash could be used for payments and each can support a discrete transaction load. This could be an opportunity for cryptocurrencies to grow without speculative excesses.