Every investment has its risk. However, high-risk investments are also often high reward. That doesn’t mean that you should stay away from them, it means that you shouldn’t put all of your eggs in one basket.
The back-up basket is called a “hedge”. Hedges are low-risk, low-reward portfolios. They won’t make you rich anytime soon but the money in a hedge is safer from market flux.
Crypto circles have been chatting lately that cryptocurrency might be a pretty good hedge. That could be much of the reason that investment firms started edging into crypto markets late last year.
So, how good of a hedge is crypto?
Why Do You Need a Hedge?
Before we talk about cryptocurrency as a hedge, it might be a good idea to briefly go over other popular investment options.
First, there’s the age-old enemy of crypto: fiat currencies. Fiat currencies aren’t a bad way to make money without mucking about in investments. If you have a good savings account, you can make pretty substantial interest on sums of money that you keep in the bank. However, to make good on the money in your account, there needs to be a lot of money starting off. Further, fiat currencies are subject to sudden and drastic changes because they are centralised. A sudden change in government can upset them easily and quickly.
Stocks are another classic investment option. In our globalised world, stocks are safe from many of the dangers of fiat currencies. Because most companies operate across national borders, governmental issues may not be make-or-break for them. However, stocks come with their own insecurities. Changes in government may not impact them but changes in the corporation can be just as dangerous. However, stocks come with a built-in hedge. Owning a wide variety of stocks in different companies – what investors call a “diverse portfolio” – can protect you from changes in any one market.
Bonds are a more complicated form of investment because they can be issued by a number of different agencies. As a result, they are subject to all of the dangers of both stocks and fiat.
Finally, commodities are things like precious metals and oil. Other than oil, the greatest danger to commodities is that they are the current popular hedge. As a result, they tend to flux in a reverse relationship with other markets. That means that sudden changes in other markets can carry over to sudden changes in commodities.
Why Cryptocurrency Can Be a Good Hedge
While we’re looking forward to the large-scale adoption of crypto as a currency, right now it’s mainly treated as an investment. And there’s a good reason for that.
Because cryptocurrency is decentralised, it isn’t subject to rapid changes in the same way that fiat currencies, stocks, bonds, and commodities can be. No domestic government can make top-down changes that drastically affect crypto as is the case with fiat and bonds. No foreign government can make top-down changes that drastically affect crypto as is the case with commodities. A single individual or small group of individuals can’t make changes that drastically affect crypto as is the case with stocks. For these reasons, crypto is safe from the factors that make other markets and currencies unsafe.
A recent article by Anton Lucian pointed out this “decoupling” of Bitcoin from these other markets. The article even called it
a hedge against chaos. However, we all know that cryptocurrency can be very volatile, making it a potentially dangerous hedge.
Why is that?
Why Cryptocurrency Might Not Be a Good Hedge
There are a number of reasons that cryptocurrency, as an investment option, suffers from volatility. Bitcoin in particular has been on a general uptrend for a couple of months, although that follows a steep fall last December.
Many crypto experts, including Lucian, chalk this up to cryptocurrency being a new market. Crypto expert Max Keiser recently said that crypto came out of that “crypto winter” as a stronger, more mature market. So far that has been true but if the crypto winter is over, it hasn’t been over long. As a result, it’s hard to say with certainty whether Lucian and Keiser are right.
A recent report by CNBC said that Bitcoin was acting as a hedge during the US-China trade war. The trade war has affected both the value of fiat currencies as well as the value of stocks. It has also been going on during a rise in cryptocurrency markets. However, this trend has not been long-enough term for some to accept crypto as an established hedge. However, if the trends continue and crypto does emerge as a hedge, it would probably prove to be susceptible to the same fluctuations that currently impact popular hedges like commodities.
Where Does that Leave Us?
If Keiser, Lucian, and company are right, crypto may emerge as a steady stable market that is an even safer hedge than commodities like gold.
If CNBC is right, crypto is developing as a hedge but that may make it a less secure hedge than it is now. Only time will tell. In the meantime, now seems like a pretty good time to buy cryptocurrency.
Jon Jaehnig is an American freelance writer specializing in Technology and Health. Jon has degrees in Scientific and Technical Communication and Journalism from Michigan Technological University and lives in Michigan’s Upper Peninsula with his wife and cat. For more from Jon, you can follow him on LinkedIn and Twitter.