The COVID-19 pandemic has caused extreme volatility across the global financial markets—and cryptocurrencies have been no exception. In fact, the performance of cryptocurrencies throughout the crisis has forced investors to rethink the role that they play in a portfolio. The increase in correlations and volatility translates to higher risk.
Let’s take a look at what has been happening in the conventional financial markets, how cryptocurrencies have performed, and what it means for traders and investors.The COVID-19 pandemic could force investors to rethink the role of cryptocurrencies in their portfolios. Click To Tweet
What’s Happening in the Market?
The COVID-19 pandemic shut down most of the world during the first half of 2020. While some economies began to reopen, the United States has seen a resurgence in COVID-19 cases in June and July that could dampen growth during the second half of the year. Most experts agree that the economy will see a series of starts and stops until a vaccine arrives.
New COVID-19 Cases in the United States – Source: Google/Wikipedia
Compounding the pandemic-led market rout, crude oil prices fell sharply during the first half of the year following a disagreement between Russia and Saudi Arabia. Prices have rebounded to about half of their prior highs over the past two months, but low demand for energy could cap gains over the coming months until demand starts to resurface.
Despite the dire economic situation, the benchmark S&P 500 index rebounded from a low of 2,237.40 in late-March to 3,232.39 in early-June—near their pre-COVID highs. Many investors believe that the economy could quickly snap back after a vaccine is developed, as evidenced by the rebound in unemployment between April and June.
Cryptocurrencies weren’t spared from the effects of the COVID-19 pandemic and collapse in crude oil prices. Like many other liquid asset classes, traders and investors sold assets to generate cash during the uncertain times. The subsequent drop in prices eventually attracted contrarian and momentum traders that bid up prices over the past two months.
|Cryptocurrency||52-Week High||COVID-19 Low||Price on July 9, 2020|
- Bitcoin prices fell 66.5% from their 52-week highs before rising 128.2% from their lows. Prices are now just 23.6% off of their all-time highs.
- Ethereum prices fell 67.2% from their 52-week highs before rising 155.5% from their lows. Prices are now just 16.1% off of their all-time highs.
- Litecoin prices fell 76.4% from their 52-week highs before rising 75% from their lows. Prices are still 58.8% off of their all-time highs.
On the other hand, stablecoins managed to maintain their value throughout the crisis and saw an influx of volume. Tether and USD Coin traded near their $1.00 per coin benchmark price—even as demand for stablecoins soared during the height of the crisis. Many investors could turn to these coins as a liquid cash-alternative during uncertain times.
Key Takeaways for Investors
Bitcoin Isn’t a Safe-Haven
Bitcoin prices closely tracked the benchmark S&P 500 index during the March decline and subsequent recovery. In fact, the 90-day Pearson correlation coefficient for Bitcoin and the S&P 500 index hit an all-time high of about 0.6 in mid-March. The long-term correlation may be lower, but correlation matters most during uncertain times.
S&P 500 Index (Red) vs. Bitcoin (Blue) Comparison – Source: TradingView
Bitcoin’s volatility also remains nearly twice as high as the S&P 500 index, making it a riskier asset for investors and far from a safe-haven asset class. After all, if investors can’t find inversely correlated assets, they at least prefer less volatile assets to limit their downside. Bitcoin proved to be a risky and highly correlated asset in this case.
Stablecoins as a Store of Value
Stablecoins have become increasingly popular throughout the crisis. For example, USD Coin has seen its market capitalization rise from about $420 million in February to more than $1 billion in July. Tether has similarly seen its market capitalization expand from less than $5 billion to more than $9 billion over the past 52 weeks.
Tether Prices Throughout the Crisis – Source: CoinMarketCap
Stablecoins have also benefited as more crypto traders choose to trade alternative cryptocurrencies, or altcoins, using dollar-backed digital tokens rather than Bitcoin. Given their inherent stability, traders can confidently use it as a liquidity tool for trading that isolates the opportunity in the altcoin, as opposed to dealing with Bitcoin’s volatility.
Crypto as an Inflation Hedge
Bitcoin is widely viewed as an inflation hedge that rises in value as the dollar depreciates. While inflation is contained at the moment, the rising national debt (which recently reached $6.7 trillion) could lead to moderate inflation following an economic recovery. These dynamics could support both cryptocurrencies like Bitcoin and other risk-on assets, such as stocks.
Government Debt Chart – Source: Bloomberg
Despite these concerns, inflation relies on an economic recovery and deflation remains a more pressing concern. Many companies are discounting prices to sell off inventory, oil prices remain sharply lower and the unemployment rate remains extremely high. These dynamics are likely to continue putting downward pressure on consumer prices in the near-term.
Capitalizing on Your Losses
The crypto market rout has provided an opportunity for investors to realize losses and offset their capital gains and regular income. By selling losing positions, traders can realize the losses and offset their capital gains and up to $3,000 of regular income. They can also roll these tax losses forward to offset future tax liabilities if they’ve maxed out the current year.
Unlike stocks, investors may be able to take advantage of tax loss harvesting without worrying about so-called wash sale rules. You may be able to sell a cryptocurrency to realize a loss and immediately repurchase the same cryptocurrency to maintain your portfolio allocations.
The best way to identify these opportunities is talking with your accountant or using a tax loss harvesting tool. ZenLedger’s Tax Loss Harvesting tool makes it easy to automatically scan for opportunities in your portfolio on a regular basis. Try it out today!
The Bottom Line
Cryptocurrencies mirrored conventional financial assets during the COVID-19 pandemic and collapse in crude oil prices—albeit with higher volatility. The performance suggests that cryptocurrencies could be less of a safe-haven asset than originally thought, although they could still become a valuable inflation hedge upon an economic recovery in 2021 and 2022.
If you’ve experienced a loss during the market rout, try ZenLedger’s Tax Loss Harvesting tool to identify ways to offset your capital gains and regular income. You can use the same platform to cut down on the time it takes to prepare your crypto taxes and ensure that you have an audit trail in place to avoid any future problems.