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The Digital Gold: A Wider Perspective



1) Correlation

When we talk about cryptos, there’s no doubt that we’re talking about a financial asset.

And as all the financial assets even cryptos have some correlation with other instruments which do influence their value, or which show systemic bounds.

Analyzing some data provided by Investigating the relationship between volatilities of cryptocurrencies and other financial assets (Achraf Ghorbel & Ahmed Jeribi) [2021]”, it is possible to understand how some important relations exist.

The result is obtained using a GARCH model (Generalized autoregressive conditionally heteroscedastic) which is a system for the variance of a time series, usually used to describe a changing, possibly volatile variance. In econometrics it is defined as a statistical model for time series data that describes the variance of the current error term or innovation as a function of the actual sizes of the previous time periods' error terms.

Just to understand what we are talking about, this is the formula of a GARCH (1,1) model:




Where ω represents a constant, ℎ𝑡 is the conditional variance, 𝜀2𝑡−1 is the unexpected past shocks (news), 𝛼 captures the short run persistence (the ARCH effect) and 𝛽 represents the long run persistence of past volatilities (the GARCH effect).

In the Table below, the results show evidence of shock transmission effects between each American index (S&P500, Nasdaq) and some selected cryptocurrencies. It should be noticed, though, that for the pair American index-cryptocurrencies, 𝛼15 is significantly positive. Consequently, this tells us that the past news about shocks in American indexes (S&P500, Nasdaq) positively affects the current conditional volatility of cryptocurrencies. Thus, through the paper analysis, we find the same results between American index-oil, American index-VIX, and American index-gold, suggesting the shock transmission of American indexes volatilities to oil, VIX, and gold returns.


Figure 1


Figure 2 shows that the dynamic correlation between Bitcoin and S&P500 is always negative and low (except during the coronavirus shock), as a result we find that Bitcoin is considered as a hedge.

Normally, one should expect that a “technologic” exchange index such as the Nasdaq would have more in common with a cryptocurrency due to their shared technological nature, but while observing the graphs we notice that that is not our case: the average correlation between BTC (or ETH) and NASDAQ is only slightly bigger, but not sufficiently in order to set an effective or different trend with respect to the SP500.


The S&P 500, a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States is a commonly used benchmark for stock portfolio performance in America, and Bitcoin, the most popular crypto in the world, may be playing the role of the dollar “opponent”, and one of this article’s aims is also to analyze whether this is true or not.


Figure 2a

Figure 2b

From Figure 3, we can observe the study of the correlation between cryptocurrencies and WTI.

WTI stands for West Texas Intermediate, one of the three major oil benchmarks used in trading and a central oil benchmark to commodities trading. Here, the correlation seems to be positive in general, with a few negative spikes in the smoothed path. The link is due to the fact that, historically, the price of oil is inverselyrelated to the price of the U.S. dollar and the relationship could be based on two well-known premises.

First, a barrel of oil is priced in U.S. dollars across the world, because the dollar represents the “stronger” currency for international export/import; so, when the U.S. dollar is strong, you need fewer U.S. dollars to buy a barrel of oil.Now, just think the same thing in terms of bitcoin. If the dollar becomes stronger, price of oil decreases, more investors will try to grab fiat currency rather than digital: in this way a positive relationship is established between crypto and oil.On the opposite side, when the fiat currency (US Dollar especially) is perceived as weaker, price of oil will go up, investors will look for digital currency, buying bitcoin, making it more expensive.


Figure 3a


Figure 3b


The same way of reasoning holds for the relationship BTC-XAU (Bitcoin and Gold).

It is well known that Gold plays an important role in financial markets with flight-to-quality in times of market distress.

A lot of times we have heard that bitcoin is “the new gold” since the supply of Bitcoin is fixed, or because gold reserves increase their value when the legal currency loses value or soundness.

Here comes the term “digital gold” and this is why we will talk about the monetary policy which affects the value of the cryptocurrency.

Establishing a new “digital” gold is not so simple: trustworthiness requirements, liquidity requirements and solidity requirements should be met in order to obtain such a prestigious status quo in the wide and global financial market. Aside from its role as a metal or a commodity, gold is one of the oldest means of exchange known to the human race. In fact, gold has a dual role as both a commodity and a currency.


Figure 4


Figure 5

As a rule, when the value of the dollar increases compared to other currencies around the world, the price of gold tends to fall in U.S. As the price of any commodity moves higher, there tend to be fewer buyers, in other words, demand recedes. In fact, many proponents argue that bitcoin will play the role that gold did in previous eras, as the central, dominant reserve currency in a wider ecosystem of digital assets.

Consequently, consistent with what we found about the relationship between Oil and Bitcoin, this suggests that the correlation between XAU and BTC will be positive. And that is true on average, and even higher than what is the correlation between BTC and WTI.


By the way, I want to specify that in this article, when I speak about cryptos, I am mainly speaking about BTC and ETH, which, in a market worth about 2tn US$, account for more than 1,2tn US$, more than 60% of the market. Obviously, they are highly related one another, but I guess you will be tired of correlation graphs at this point. By the way their correlation (for the last year) sticks between +0,75 and +1.


2) Volatility

In 2020, that volatility factor has not gone away and remains bitcoin’s biggest nemesis (or allied?) with respect to wider public adoption (especially as a form of money). But from a trading and asset perspective, there is some justification in embracing the idea that bitcoin volatility is also an important window into market forces that are otherwise being suppressed. Central banks, whether rightly or wrongly, have worked hard to eradicate volatility from the financial system at the cost of ballooning balance sheets and centralised support for specific asset classes. A decisive move by institutional money out of central bank systems and over to bitcoin is turning any related volatility into a measure of that suppression. [Izabella Kaminska, December 18th, 2020, Financial Times, “The year bitcoin went institutional”]


The price of bitcoin has been explosive over the past year, but the volatility remains stomach-churning, which will put off many serious investors and virtually all corporate treasurers outside of Tesla, industry executives note. It is hard to claim to be a store of value when prices can often move around by 5-10 per cent in a day.[Eva Szalay, London, 12th February 2021, Financial Times, “Digital Tulip or new asset class? Bitcoin’s bid to go mainstream”].


Figure 6


It is to be said, that is so arduous to idealize a digital currency as an unfailing, steady, and enforceable storage of value against the fiat money when simple tweets or corporate decisions could trigger such big changes in price, but we will walk through this later, in the following paragraphs.


Through the scrutiny of a curious and intriguing paper named “Bitcoin is not the New Gold”, published by The International Review of Financial Analysis, it is well recognizable that Gold provides that hedge, which confirms the findings of the previous section. Gold may not fully protect from market drawdowns, but the hedging properties are clearly pronounced. The minimum-variance portfolios of Gold and the indices have a higher average return during times under distress instead of bitcoin.

The paper itself hints that if we would want to build a Minimum Variance Portfolio (red one made up of Gold and SP500, blue one made up of Bitcoin and SP500), the weights of the assets should be completely different as reported in the plot, that is another deduction which moves us away to consider Bitcoin ready to replace Gold as the new “flying-to-quality” escape.


3) Social Networks

As physicians have in mind the most famous Albert Einstein’s formula, E = mc2, economists (and especially fundamentalists) bear in mind the original Benjamin Graham Formula for finding the intrinsic value of a stock: V = EPS (8.5 + 2g). It means that V, the intrinsic value of a stock, is equal to the Earning per Share of the last 12 months times 8.5 (= P/E ratio of a zero-growth stock) plus two times g, which stands for the long-term growth rate of the company​.

The difference between the two formulas is that the first one is still applied while the second isn’t.

If we consider and evaluate the latter and contemporary market episodes, it is simple to figure out that Graham’s model is not the norm. Investors run short of time, or they know too little, or they listen to bad advice, or they are over-confident, or they fall prey to biases. In other words, they exhibit what the economist John Maynard Keynes called “animal spirits” and what another economist, Herbert Simon, called “bounded rationality.”

The type of rational investing in which day traders buy stocks purely because they have understood a company’s fundamentals was rare even before GameStop and Musk. In fact, it is possible to argue that it is rare even among institutional investors today, given how much trading happens second-to-second, driven by algorithms that crunch vast streams of often unrelated data.

“The fact that a thesis is flawed does not mean that we should not invest in it as long as other people believe in it,” George Soros, a seasoned speculator who referred often to the Keynesian beauty contest, wrote in “The Alchemy of Finance.”

The market is set up to reward that kind of approach as well, at least in the short term. That it does so even with Dogecoin, a cryptocurrency named after a meme dog, is a reflection not of the irrationality of the investor but of the caprice of the market itself.


Before showing you to the case, let me introduce you Dogecoin.

Dogecoin was co-founded by IBM software engineer Billy Markus and Adobe software engineer Jackson Palmer, who set out to create a peer-to-peer digital currency that could reach a broader demographic than Bitcoin. In addition, they wanted to distance it from the controversial history of other coins. Dogecoin was officially launched on December 6th, 2013, and within the first 30 days there were over a million visitors to Dogecoin.com.

Dogecoin has also been used to try to sell a house, in the pornography and poker industries; moreover, Dogecoin's implementation differs from Litecoin by several parameters, relevant to mention, Dogecoin's block time is 1 minute as opposed to Litecoin's 2.5 minutes.


Figure 7


With the intention of getting the idea of Dogecoin’s story, in figure 7 there are some of the Tweets which Elon Musk (CEO of Tesla) posted about Dogecoin during the first half of February 2021.

I tried to inspect and investigate the changes in the price of Dogecoin looking at those social network “inputs” which are basically the idea (more or less sincere, you decide) of a market participant, not certainly a “fundamental” or effective change in the intrinsic economic value of that currency.

In figure 8a, there is the graph I developed using a Linear Regression with one Upper Standard deviation and one Lower Standard deviation, 150 obeservation for the ‘’conservative’’ graph and 50 obs for the ‘’short term’’ graph (fig. 8b), the black line stands as the Moving Average (15 obs in graph 8a and 9 obs in graph 8b).


While writing, the price of Dogecoin is 0.055$.


Figure 8a

The second graph, developed with less conservative hypothesis (Linear Regression with only 50 observations) granted an average price above 0.07$ while the more conservative graph suggested a better 0.05$.


Figure 8b

It is striking to see how Dogecoin’s price alters. Because after a period of rise and fall, it begins to act in an almost identical manner as bitcoin does (around February 22), and indeed the red area of ​​the correlation, close to 1 in the very next following days, confirms all these thoughts.

It seems like that the coin, after an initial shock, has had overtook that critical volume of trading (or “market perception volume”) needed in order to be felt as a Crypto from the traders. But there is more, because the Musk’s social media campaign for cryptos didn’t stop here.

I set 2 crosses in order to mark the increases in the Dogecoin value after Elon tweets and a Linear regression function for that period (which is obviously hyper inflated, but just to give you the idea of the “loosing fundamentals” trend which is surrounding us).


Figure 9


After all, we can suppose that a certain percentage of retail investors tend to see Dogecoin & Bitcoin as a portfolio of currencies which belongs to Musk, and they blindly follow what he says. That is a little bit scary because the market is made by people, and we can try to implement and create the highest sophisticated algorithm and financial models, but at the end, if things work controversially, our work could be vanished.


Hodl is slang in the cryptocurrency community for holding a cryptocurrency rather than selling it, more precisely, it means ‘Hold On for Dear Life’. When times are tough in the crypto markets, everyone repeats the mantra ‘just HODL’ meaning ‘just hold instead of trading’. HODL today is indeed elevated to the status of a meme in the crypto industry because there is nothing else we can do in the game of supply and demand.

Social medias play an important role influencing the younger generation, which is more exposed to the cryptocurrencies (since cryptos is a relatively “young” phenomenon), and, as a consequence cryptos find themselves highly influenced by social trends and Musk seems to be well aware of this.


Even this point leads us to confirm that we cannot yet idealize Bitcoin as a reliable archiving and storage tool of stable value, when just a few tweets are enough to cause huge changes. Also supporting EMH (Efficient Market Hypothesis) could be somewhat impossible.


Some of the investment industry’s old guard think the current frenzy is abhorrent. Charlie Munger, the 97-year-old vice-chairman of Berkshire Hathaway, recently described the GameStop episode as a “frenzy” led by a “new bunch of gamblers” who have “the mindset of racetrack betters”. Robinhood responded that Munger’s views were “disappointing and elitist”. The response on r/WallStreetBets was more partisan. In one of the more printable comments, Reddit user ever_onward said: “Mind your own business grumpy gramps.’’

[Rise of the retail army: the amateur traders transforming markets, Financial Times, Katie Martie, London, 9 March 2021]


One could object that maybe this kind of “Hype” and sick behavior is due to the fact that Dogecoin is an extreme young and more unknown cryptocurrency, but an analogous thing happened with Bitcoin, after the announcement of Tesla to invest 1.5 bn US$ in BTC, which caused a 40% increase in the BTC price. Surely,this operation experienced a distinguished success as it took place after the consolidation of Tesla within the SP500, which increased the financial prestige of the latter.

(In the following graph, there is a note just to precise that after some days from the Tesla’s announcement, Musk tweeted that BTC price seemed just “too high”, and immediately price dropped…)


Figure 10


4) Monetary Policy

In the case of Bitcoin, there is no central bank constantly issuing money and controlling monetary policy. Instead, there is an algorithm that runs out once it hits 21 million coins. After that, any BTC that get lost is permanently removed from the money supply, meaning the total supply will decrease, or deflate over time. As a result, BTC will become increasingly rare and increasingly valuable.

On the other hand, Bitcoin is deflationary, meaning buying power increases over time. If you put your private key under your mattress for 20 years (assuming Bitcoin is still around in 20 years), it will buy you more then than it will today. Your incentive is to save the Bitcoin and not to spend it, since it will likely be worth more in the future. This leading to a deflationary circle, as a result, there is a problem of liquidity, meaning that you can mine/buy bitcoin, but you could have very significant problems when selling. We will address this topic later.

But why are we concerning about inflation right now (especially now that we are living in times where it doesn't seem to be such a strong inflationary boost), I mean, what is happening with inflation right now?


Figure 11


Now, more than ever, subsequentially to the colossal and enormous easing policies of the western Central Banks, inflationary hedges are important, therefore Bitcoin might play the part of this role for the 21st century, as gold did for the 20th century. Last but not least, bear in mind that we are assessing if Bitcoin can pose itself as the New Gold, and so, inflation risk matters.


A venture firm called Panter Capital became famous some weeks ago after saying “the United States printed more money in June than in the first two centuries after its founding. Last month the U.S. budget deficit — $864 billion —was larger than the total debt incurred from 1776 through the end of 1979.” [Two Centuries Of Debt In One Month : Pantera Blockchain Letter, July 2020].

As a result, each time that central banks start printing money (through the mechanism of quantitative easing –QE–, i.e. a monetary policy whereby a central bank purchases at scale government bonds or other financial assets in order to inject money into the economy to expand economic activity), it can represent an encouragement for Bitcoins to be perceived as the good alternative to fiat money, as a consequence their value will rise.

This happens because through QE, after a primary “impact phase”, which spots an ample growth of broad money (i.e. money in any form including bank or other deposits as well as notes and coins) and real asset price, we fall in the secondary “adjustment phase”, where the real asset price decreases, the broad money keeps its level and inflation tends to be remarkable for a considerable time span. As long as this mechanism is alive, and investors understand it, fiat money tends to lose value, and BTC tends to increase their value. This because of a twofold reason, first of all you will need more fiat money in order to buy 1 BTC, then secondly, people will now have a wobbly perception of the legal currency, preferring to invest in the digital one, which doesn’t show any “inflation” related controversy, since it’s not guarded by a central bank.


Figure 12


In addition to the well-known certainty of the financial asset prices upturn due to the expansionary policy, it is phenomenal the growing attention of many professional investors. Alike a multitude of callow and amateur users, forced to reduce consumption during pandemic lockdowns which have heightened their financial investments thanks to savings. In fact, the audience of cryptocurrency investors has changed a lot over the years. At first it was mainly IT experts who were interested in it, fascinated by the revolutionary potential of the blockchain and the libertarian soul of a currency not controlled by central banks.


5) Liquidity

The magical power of liquidity: to transform assets in cash.

Our analysis shows that currently 78% of the circulating Bitcoin supply (14.5 million BTC) can be classified as being illiquid. A trend that has been increasing over the course of 2020 and paints a potential bullish picture for Bitcoin in the upcoming months, as less BTC are available in the network to be bought.

Up to now, the illiquid supply counts for 10.3 million BTC, the liquid one for 1.2 million BTC and the highly liquid supply for 3 million BTC.

The liquidity premium plays an important role when we refer to Bitcoin: indeed, it is essentially an increase in the price of an illiquid asset demanded by investors in return for holding an investment that cannot easily be sold. The more illiquid the investment, the greater the liquidity premium that will be required to compensate.Liquidity premium for BTC is high since we cannot sell it easily, thus we could be in front of a “pumped” high value if we ensue this hypothesis.

I want to wrap up this section by providing you a schematic and graphic view of what the pillars are for the sake of liquidity, and what is their health condition when we refer to the crypto world. In general, if trading volume rises, fees per transaction decline, the number of active traders arise and the number of transactions using that currency soar, as a direct result the bid-ask spread grow shorter and a greater liquidity degree is reached. Just to remember, 1 BTC was worth 5.618€ during April 2018, and now (3 years later) is worth 48.552€, with a yearly price growth of 205.21% (gross growth of 864.22%). So, one should expect the same growth in the trading volume, such as in the number of transactions through BTC per day, and a big reduction of the fees.


Fee per Bitcoin transaction has increased.


Figure 13


In one of the most developed financial market, the UK’s financial market, the trading volume has never recovered after the pump and dump of 2017-2018.


Figure 14


The number of transactions with Bitcoin has been oscillating around the same level (more or less).


Figure 15


6) Conclusion: The Everything Bubble

After all, I believe that the correct innate value of a financial asset – such as a good, or a service – should be associated and parallel to fundamentals which compound the asset (or the good) itself. If we think about a smartphone, we pay for the multiple services it provides us; if we buy a pair of socks, we pay for the extremely simple and notably useful service that they furnish. When we purchase a bitcoin, we should think about its authentic and native function, what it was invented for, that is, at the end of the story, its functioning as a mean of exchange.

[Growth of transaction per day using BTC 1/1/2018-31/3/2021 = roughly -9% yearly (-30% gross growth); Growth of Bitcoin price 1/1/2018-31/3/2021 = +205% yearly (864% gross growth)]


Obviously the past 14 months have been so strange and at the same time hugely positive, after the Covid plunge of February-March 2020, for the prices either in the equity and in the crypto market, and I would want to conclude giving you a wider perspective.


One last question, will excessive monetary and budget policy experimentation end in tears?

Desmond Lachman, economist and finance author, was a Senior Advisor and then Deputy Director at the International Monetary Fund, and a few weeks ago has given his respectable opinion on the current prices situation: “While the Biden administration believes that this experiment will usher in a period of prolonged and stable economic growth, an influential group of distinguished economists, including former Treasury Secretary Larry Summers and former International Monetary Fund (IMF) chief economist Olivier Blanchard, believes that it will result in an unwelcome inflationary burst and another leg down in the economy.

There is also the distinct possibility that inflationary fears will lead to higher interest rates that would burst today’s everything bubble. That, in turn, could lead to the sort of global financial market dislocation that followed the September 2008 Lehman bankruptcy and that produced the deflationary Great Recession. One indication of today’s extraordinary economic policy experimentation is the very rapid rate at which the Federal Reserve is printing money. In the short span of nine months, Fed Chairman Jerome Powell has increased the Fed’s balance sheet size by a staggering $4 trillion through the Fed’s highly aggressive bond-buying activities. That, in turn, has led to a 30 percent increase in the broad money supply, which is by far the fastest rate of such growth in the past 60 years. Also overlooked is the fact that today’s global everything bubble is premised on the indefinite maintenance of ultra-low interest rates. But if the expectation of an overheated economy forces interest rates higher, there is the distinct risk that today’s equity and credit market bubbles could burst”.


By the way, Mr. Powell (chair of the Federal Reserve) has been nominated as the “crypto Person of the year” by Forbes, but I would suppose that maybe this is only snark, after reading what Desmond Lachman says.



Author: Michele Mombelli


Disclaimer: the article was written on the 9th of April

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