As Bitcoin skyrocketed last year, the crypto crowd (as well as a sizable contingent of otherwise sane people) bent over backwards to try and explain how Bitcoin is akin to gold.
And you know, if you’re going to go out and try to compare Bitcoin to gold, I guess it makes sense to approach it that way. That is, if you’re going to compare Bitcoin to gold, it’s probably best to make a list of the reasons why the two are alike because if you do the opposite (that is, make a list of all the reasons Bitcoin and gold are not alike) we’ll be here all fucking day.
So thanks to all of those people who endeavored to explain why Bitcoin is like gold, because you inadvertently saved everyone a lot of time by approaching it from that angle.
Needless to say, Bitcoin is not gold and if you want an explainer on why it’s not gold, please see here.
Amusingly, anecdotal evidence suggests that as Bitcoin plunged this month, investors were scrambling to buy gold, apparently on the assumption that a collapse in cryptos might well bode poorly for risk assets in general.
That brings us neatly to a new Deutsche Bank note which suggests that far from a safe-haven, Bitcoin and cryptocurrencies more generally represent the “new frontiers of risk-taking” and in that sense, they are more like short VIX ETPs than they are gold.
“The current ‘triple-low environment’ of low interest rates, low spreads, and low volatility has given birth to new asset classes like implied volatility (ETFs selling volatility), and cryptocurrencies,” the bank’s Masao Muraki, writes, adding that “the prices of both asset classes have plummeted and rebounded simultaneously and in 2018, correlation between Bitcoin and VIX has increased dramatically.”
Over the past year, the calls have grown louder with regard to the feedback loop embedded in markets thanks to vol. selling and systematic strats. Technically speaking, the worry is that thanks to the low starting point, a nominally small spike in volatility could force levered and inverse VIX products to panic buy VIX futs into said spike, thus exacerbating the situation and forcing the systematic crowd to deleverage into a falling market. In his year-ahead outlook, JPMorgan’s Marko Kolanovic suggested that this dynamic (which he calls “quantitative exuberance”) is one reason why we don’t need to see “irrational exuberance in the ‘tech bubble’ sense” in order to get a crash. To wit:
The reason is the prevalence of quantitative and passive strategies that don’t decide based on emotions, but rather based on measures such as the level of interest rates, volatility, price momentum, or bond-equity correlation. Examples of these strategies include Volatility Targeting, Low Volatility strategies, Trend Following strategies, Risk Parity strategies, Dynamical hedging strategies, Volatility selling strategies, and others. In addition, there are relative value strategies that transmit risk premia compression across asset classes and strategies. With volatility at record lows and central bank balance sheet inflows peaking this year, these strategies currently experience ‘quantitative exuberance’ that poses risk when monetary policies start normalizing in a meaningful way next year.
Citi put things more succinctly last month:
Trades and strategies which explicitly or implicitly rely on the low-vol environment continuing, are becoming more and more ubiquitous.
Implicit in all of that is the notion that the tail is now wagging the dog and Deutsche’s Muraki says just that in the noted mentioned above:
Implied volatility is an index calculated from the price of a derivative product (options) of an underlying marketable security. However, we now have a “tail wagging the dog” situation where the price of the derivative product is feeding back into the price of the underling marketable security. Investors required to seek out high returns, even in the current “triple-low environment,” are under pressure to manage assets near their fund’s value-at-risk (VaR) upper limit (CTA, macro funds and volatility-targeting funds such as variable annuity funds and risk parity funds). This means that, structurally, they will increase their holdings of stocks and other risk assets when volatility declines, but reflexively dump risk assets when volatility rises.
For Muraki, cryptocurrencies pose a similar risk because, again, they are part and parcel of the new frontier of risk-taking. To wit:
Cryptocurrencies are closely watched by retail investors, affecting their risk preferences for stocks and other risk assets. Although institutional investors recognize that stocks and other asset valuations may have entered bubble territory (US equities’ average P/E is around 20x), they cannot help but continue their risk-taking. Now, a growing number of institutional investors are watching cryptocurrencies as the frontier of risk-taking to evaluate the sustainability of asset prices. The result is that institutional investors, who are supposed to value assets using their sophisticated financial literacy, analysis, and information-gathering strengths, are actually seeking feedback about the market from cryptocurrency prices (which are mainly formed by retail investors). We believe the correlation between Bitcoin and VIX can increase as more institutional investors begin trading Bitcoin futures.
And there you go. Another way for cryptocurrencies to morph into a systemic risk and another example of how, thanks to the advent of Bitcoin futures, cryptocurrency risk now has an explicit transmission channel to other markets.
Hilariously, this would be a dynamic that the doomsday bloggers would be shouting from the rooftops about if what was being discussed was anything other than Bitcoin. But because that crowd is pot-committed to being fanatical Bitcoin fans by virtue of cryptocurrencies’ anti-establishment characteristics, they are hamstrung in their ability to flag the obvious risks.