The COVID-19 crisis and subsequent crude oil crash has taken an unprecedented toll on the global economy. While cryptocurrencies have a historically low correlation with traditional asset classes, the significant drop in crude oil prices could impact crypto assets in some unexpected ways.
Let’s take a look at how depressed oil prices could impact cryptocurrencies over the intermediate- to long-term.The significant drop in crude oil could impact crypto assets in some unexpected ways. Click To Tweet
Crude Oil’s Massive Fall
The COVID-19 crisis has led to a sharp drop-off in demand for crude oil. Global lockdown measures cut average road transportation activity to half of last year’s levels and electricity demand could fall by 20% or more. In April, crude oil demand fell by a massive 29 million barrels per day.
Along with depressed demand, a disagreement between Saudi Arabia and Russia led to a sharp increase in crude oil supply. Prices briefly went into negative territory on April 20, leading to concern over the solvency of higher-cost producers in the United States and punishing many oil-producing countries.
Crude Oil Prices Remain Depressed – Source: Finviz
The good news is that crude oil prices started to rebound after OPEC and Russia agreed to a historic 10 million barrel per day cut due to pressure from the United States. While crude oil prices remain significantly lower than they were in February, there are some signs of recovery as demand starts to pick up.
Flight to (Crypto) Safety
The COVID-19 crisis and the collapse in crude oil prices has led investors to seek out safe-haven asset classes. While gold remains the most popular safe-haven asset class, cryptocurrencies could become a viable alternative as they tend to be uncorrelated with conventional asset classes.
Bitcoin Correlation with S&P 500 – Source: Coinbase
While Bitcoin has had a positive correlation with the S&P 500 in recent months, prices have moved independently of the benchmark index throughout most of its history. The opposite is true for many blue-chip equities and other risk-on asset classes that have a very high correlation with the S&P 500.
It’s important to note that the lack of correlation doesn’t necessarily mean that cryptocurrencies are less risky. In fact, many crypto assets have higher volatility than equities. The benefit of holding uncorrelated assets is simply that the overall portfolio could experience less volatility.
Lower Energy Costs for Miners
The drop in crude oil and natural gas prices has cut energy prices around the world. For crypto miners, lower energy costs translate to higher profit margins as energy accounts for a significant portion of their operating expenses. And higher profit margins could encourage more mining activity.
Many large crypto miners use long-term power supply contracts to lock in wholesale electricity prices. While some of these miners may be able to lock in lower energy prices for long-term contracts, many are stuck in existing power supply contracts at higher prices at the moment.
Bitcoin Supply Growth – Source: Blockchain.com
While lower input costs would normally increase supply, the impact depends largely on the cryptocurrency. Those using proof-of-stake algorithms aren’t affected by energy costs while the impact for proof-of-work-based cryptocurrencies depends on their internal dynamics — especially in the case of Bitcoin.
Bitcoin’s halving occurred on May 11, cutting the reward for miners by half. The every-four-years event caused many miners to shut down or scale back operations as it became more difficult to turn a profit with older machines. As a result, the supply is likely to decrease in the near-term.
Pressure on Petro-Dollars
The U.S. dollar has played a critical role in the energy market since the Bretton Woods Agreement established the U.S. dollar as the de facto global currency. Crude oil and other commodities are traded in dollars, which means that everyone depends on the strength and stability of the dollar.
The U.S. government’s sanctions against Venezuela and Iran and concerns over the dollar’s stability have some countries looking for a replacement. Russia, China and Iran have been active in the cryptocurrency space and the COVID-19 crisis and crude oil glut could lead them to explore their options.
Venezuela introduced its own cryptocurrency—called the Petro—that was supposedly backed by oil reserves. While that project has failed to take off, Russia expressed interest in launching an oil-backed Neft-Coin last year. The UAE and Saudi Arabia have also worked on a joint cryptocurrency project.
These projects remain in the early stages, but with COVID-19 spending pushing national debts higher, the dollar could lose some of its status as a global reserve currency. Without a viable alternative in place, countries could begin looking at these cryptocurrency projects more seriously than ever before.
The Bottom Line
The COVID-19 crisis and subsequent crude oil crash could have a surprising impact on cryptocurrency prices over the short- and long-term.
The most obvious is the flight to safety, which has led some traders and investors to look at cryptocurrencies more closely. With lower energy prices, miners in proof-of-work cryptocurrencies could be encouraged to increase supply, which could put downward pressure on prices. The COVID-19 crisis could also lead to some long-term changes in the way that the massive oil trade operates on a fundamental level.
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