How Covid-19 and Bitcoin’s Halving Created the Perfect Storm
It All Began in 2008
Before the Covid-19 pandemic gripped the world, the 2008 global financial crisis was widely regarded as the worst economic disaster in recent history, after the Great Depression.
Beginning with the collapse of the US housing market, the 2008 “credit crisis” sent the global financial sector into a tailspin that brought down investment banks, commercial banks, mortgage lenders, insurance companies, and many other credit-reliant industries in its wake.
In the aftermath, global economic growth came to a standstill. Governments responded by bailing out banks and large corporations through aggressive Quantitative Easing (QE) – a monetary policy whereby central banks simultaneously print money and lower interest rates in order to stimulate borrowing and spending activity.
Economists and financial experts are still measuring the full impact of 2008’s Quantitative Easing policies. Many cautioned early on that this wave of money printing and bail-outs could eventually lead to inflation or even hyperinflation.
Now, in the wake of the global pandemic, we find ourselves in the midst of another aggressive wave of QE, on a much larger scale. By July 2020, just five months into the Covid-19 pandemic, many governments’ stimulus spending had already surpassed that of the 2008 recession, by a long shot.
But there is a key difference between post-2008 QE and post-pandemic QE, and its full impact has yet to be felt.
In the wake of the 2008 crisis, the majority of the new money that was printed was held in excess reserves with the Fed. These excess reserves are used by commercial and private banks to make payments to each other, so this new money supply didn’t actually make its way into the hands of the banks’ customers. This meant that the US, for the most part, managed to keep excessive inflation at bay.
Pandemic-era QE, however, is different. This time, Governments including the US and Canada have opted to increase the money supply and give it directly to citizens and businesses via stimulus cheques, in order to keep people spending and prop up the economy.
Which means a lot of extra money is already in circulation. Which is exactly what can lead to inflation.
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When Savers are Losers
This brings us to another adverse effect of the long-term effects of QE: it rewards spenders while punishing savers. Lowering interest rates means that borrowing money becomes cheaper, while savers are no longer generating interest by holding their cash in a bank account.
Most people are now earning close to zero interest on savings held in a bank, and as a result they are forced to turn to other means of building a “nest egg” and protecting it from inflation, , such as investing in stocks or buying real estate – neither of which comes without risk. And while lower interest rates means mortgage rates have been slashed in many countries, this drop in interest rates often has the effect of driving up housing prices. . So while the interest paid on a loan to buy a home is cheaper, because housing prices have increased so dramatically over the past few decades and have been pushed even higher due to the cheaper cost of borrowing, ultimately people have to borrow a lot more money to pay for a home. Eventually, interest rates will likely need to be readjusted (although the Fed has promised not to raise rates throughout 2023), and anyone who took out a 25-year mortgage when interest rates were low will likely be in for a rude awakening.
According to the Financial Times, the measure of broad-based money supply, or M2, jumped 24% between March and November 2020. “Shockingly, the money supply surge in 2020 exceeded any in the one-and-a-half centuries for which we have data,” The FT reports.
With all these extra dollars in circulation, the value of fiat money decreases, which negatively impacts peoples’ savings. Because interest rates are lower, savers also aren’t earning interest on their existing savings, while borrowers are rewarded for taking on debt. Meanwhile, all this extra liquidity is making its way into the stock market and pushing up asset prices. So people are ultimately paying more to buy stocks and real estate than they would in a normal market.
Pandemic-era QE- Another Nail in the Coffin for Fiat Currency?
McKinsey estimated in 2013 that the Fed’s post-2008 QE policy had cost savers $360 billion.The full extent of this latest round of pandemic-induced QE has yet to fully work its way through the financial system. But after several rounds of stimulus cheque handouts that have totaled more than $3 trillion in the US alone so far, there will be more money than ever before in circulation.
Gold stocks and cryptocurrencies have been rallying in response, as people seek out safe haven assets in the face of a weaker US Dollar and mounting fears of impending inflation.
“As the Federal Reserve and Government continue to practice aggressive quantitative easing and print trillions of dollars to stimulate the economy, we’re seeing a lack of trust in the U.S. Dollar continue to emerge,” says Steve Ehrlich, CEO and co-founder of online cryptocurrency brokerage platform Voyager Digital (CSE: VYGR; OTC: VYGVF) and former CEO of E*Trade. “The number one development we’ve been seeing at Voyager is the massive influx of retail growth. So many people are racing into the market to buy Bitcoin, and turn their cash into digital gold.”
In the Midst of the Pandemic, People Have Been Buying Bitcoin
In perhaps the most obvious sign that people are losing faith in fiat currency altogether, back in April 2020 it was reported that US citizens who were receiving stimulus cheques from the US government were using the extra cash to buy Bitcoin.
This brings us back to the 2008 financial crisis, which also served as the catalyst for the creation of Bitcoin. The digital currency came into existence in January 2009 as the antithesis to modern-day, government backed fiat currency.
Unlike government-issued fiat currencies, Bitcoin is operated by a decentralized authority: it is created, distributed, traded and stored using a public, decentralized ledger system known as blockchain.
“The fundamentals of Bitcoin have never been stronger, due to its increasing scarcity, its reputation as a hedge against inflation, and the massive institutional adoption buying up the circulating supply,” says Ehrlich.
Bitcoin – the Deflationary Currency
How can Bitcoin be a “hedge against inflation”? Bitcoin uses peer-to-peer technology to facilitate instant payments. It offers lower transaction fees than traditional online payment systems, and because there is a limit to the number of Bitcoins that can ever exist in circulation (21 million), it is considered a finite, deflationary currency.
Unlike fiat currency, the number of Bitcoins in circulation cannot be manipulated by governments and central banks. Bitcoin mining is the only process by which new Bitcoins can be released into circulation, and Bitcoin miners, which can be individuals or companies, are thought of as the decentralized authority enforcing Bitcoin’s credibility as a currency.
“Bitcoin’s value mirrors the adoption of the curve of the network – you can think of Bitcoin more like a social network than a stock,” says Ehrlich. “The more people powering the network – the largest decentralized computing network in the world – and the number of investors using the network, the more value it has.”
What is Bitcoin Halving, and Why Does it Matter?
Mining Bitcoin requires the solving of complex mathematical puzzles in order to discover new blocks, which are then added to the blockchain. The mining process requires not only time but also an enormous amount of power. In return, miners are rewarded for their efforts with a few Bitcoins.
However, this reward is reduced by half for every 210,000 blocks that are mined, an event known as the “halving” or the “halvening”, which has occurred roughly every four years since Bitcoin’s inception, and will continue to happen until all 21 million Bitcoins are mined – estimated to occur in the year 2140.
Since its inception, the price of Bitcoin has consistently surged in the 12-18 months following each halving, as the amount of new Bitcoin entering circulation every day drops, while the cost of mining Bitcoin rises and the amount of unmined Bitcoin becomes even harder to attain.
The most recent halving, which barely made headlines in the midst of the Covid-19 pandemic, occurred in May of 2020. Miners must now use ever more complex and expensive computational hardware, which requires enormous amounts of power, to mine Bitcoin. And just like the previous halvings of 2012 and 2016, here we are now in February, roughly 9 months after the May 2020 halving, and the price of Bitcoin has reached a new all-time high, surging to USD $58,332.36 on February 21th.
“Bitcoin is undergoing a supply-shock”, says Ehrlich. “With demand far outweighing what’s available on the market, investors expect the price to continue to rise.”
Hedging Your Bets on Bitcoin: Who are Retail Investors Competing With?
Because Bitcoin has a fixed supply, it has created a system that rewards savers as the Bitcoin becomes increasingly harder to accumulate. It is an appealing currency for those who fear that fiat money – the kind issued by governments – can lose its value to inflation if too much is printed.
And, unsurprisingly, governments and other regulators aren’t exactly wild about a currency that they don’t control the supply and demand of.
On January 19th, Janet Yellen, U.S. Treasury Secretary, called for more regulation of cryptos, saying that the majority of them were used for what she referred to as “illicit” purposes:
“I think we really need to examine ways in which we can curtail their use and make sure that money laundering doesn’t occur through those channels,” said Yellen of cryptocurrencies.
This begs the question: could governments intervene and ban the use of cryptocurrencies altogether?
“No financial instrument is truly independent from government intervention,” says Ehrlich. “At Voyager, we believe that more regulations are necessary for the growth and mass adoption of the crypto market, and we welcome it. While the government may step in, we’re seeing much more positive progress on the embracing of this revolutionary ecosystem, than the outlawing of it.”
Could we be heading towards a world of government-backed cryptocurrencies?
“Regulators have been putting policies in place to both embrace cryptocurrencies as well as implement better procedures to monitor the companies and people using them,” Ehrlich says. “We expect this new administration to understand the essential value of crypto and blockchain, and for cryptocurrencies to emerge as an essential part of our increasingly digital world.”
What’s a Retail Investor to Do in This Market?
Bitcoin has been embraced by retail investors, who regard it as a safe haven asset that can protect them against the devaluation of fiat currencies. Paul Tudor Jones, Stanley Druckenmiller, and even the ultra-conservative ‘all-weather portfolio’ manager, Ray Dalio are some of the Wall Street legends that have publicly joined the ranks of “Bitcoin believers” recently. But institutional investors are still cautious when it comes to endorsing cryptos – at least publicly – and they often manage to contradict themselves in the process.
On January 5th, JP Morgan – whose CEO Jamie Dimon previously called Bitcoin a “fraud”, just before the investment bank released its own cryptocurrency called JPM Coin – said in a note that Bitcoin could rally as high as $146,000 in the long-term. But only if its price volatility stabilizes enough for institutional investors to make larger bets.
However, by late January, after the price of Bitcoin had dipped back down to $31,000, analysts at JP Morgan reversed course – warning investors that Bitcoin “may never break out past $40,000 again.”
They warned that the risk of investors withdrawing their profits after the $40,000 breakout was too high, and the majority of buying activity was now shifting to “HODLers” (Hold On for Dear Life-ers), retail investors who buy Bitcoin with the intention of holding it indefinitely, viewing it as a store of digital “gold”.
In light of the GameStop short squeeze, it’s interesting that an investment bank felt the need to warn the public about the behaviour of retail investors. And anyhow, lo and behold, these analysts were wrong – just a few weeks later, Bitcoin broke out past $40,000 again.
In contrast to JP Morgan, Ehrlich is looking at the future of Bitcoin and other digital currencies optimistically, especially because crypto buyers can earn interest – a huge draw for savers who no longer feel their nest egg is “safe” from the inflation that fiat currencies are subject to.
“Since crypto is so efficient, operates 24/7, and doesn’t have the overhead of traditional finance, the lending ecosystem has been growing at a record-breaking pace,” he says. “With the average bank offering as little as 0.25% interest on savings accounts, we’re seeing thousands of customers turn to Voyager to earn up to 8.5% interest APR on USDC, which is a stablecoin, and 5.5% on Bitcoin. Aside from Bitcoin, we’re also seeing incredible interest in Ethereum, and the altcoin market, as the immense value of blockchain technology is becoming realized by mainstream investors,” he adds.
So, as a retail investor, should you be buying Bitcoin or other cryptocurrencies?
“In 2020, Bitcoin was one of the absolute best-performing safe-haven assets in the world, and we expect this trend to continue into 2021,” says Ehrlich. “While we cannot give investment advice, we do think cryptocurrencies are an important part of every modern investor’s portfolio. Just like de-risking a traditional financial portfolio, cryptocurrency investing adds another level of diversification and asset allocation to an investor’s portfolio.”
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