Cryptocurrencies are often compared to gold. They have a number of features in common – independence from governments, limited emission, and a user consensus ascribing value to them. This is especially true in the case of bitcoin, the first cryptocurrency that still retains the status of the “default crypto”, just like gold retains the status of the most important precious metal.

However, cryptocurrencies are also vastly different from metals: they are a lot easier to trade. Below Victor Argonov, Analyst at EXANTE, explains more for Finance Monthly.

Physical gold is extremely difficult to buy, sell, and trade across national borders, and nearly impossible to use as legal tender. Gold turnover is subject to heavy taxation, and many prefer to invest in precious metal accounts instead of physical gold. Cryptocurrencies, on the other hand, are easy to buy and sell, can be freely traded across borders, and their use as legal tender is becoming increasingly more common.

These similarities and differences between cryptocurrencies and precious metals are common knowledge. However, one crucial question remains unanswered – how much they are able to function as a protective asset, retaining their value during crises.

Theoretical Considerations

Currently, one of the key arguments against the use of cryptocurrencies as protective assets is their high volatility. BTC cost $0.1 in 2010, $1,000 in late 2013, $200 in late 2014, $19,000 in late 2017, and around $7,000 today. Even just in 2019, which can hardly be called a particularly volatile year, its exchange rate still fluctuated by a factor of four over the year. Crashes are commonplace on the market, and no matter when you buy cryptocurrency, there is no guarantee that your capital is not going to halve in a month.

On the other hand, the key argument for keeping one's funds in cryptocurrency is its tendency to grow in value as the number of its users increases. Cryptocurrency emission is limited by algorithms. With BTC specifically it is actually decreasing, which minimizes inflation. Currently a few dozen million people on Earth use cryptocurrencies, and their number doubles every year. Even 2018, disastrous as the year was, saw the number of users increase from 18 to 35 million. At the same time, the potential new audience is still huge, and in tandem with guaranteed low inflation it usually stimulates growing exchange rates, regardless of the bubbles that may occur.

The key argument for keeping one's funds in cryptocurrency is its tendency to grow in value as the number of its users increases. Cryptocurrency emission is limited by algorithms. With BTC specifically it is actually decreasing, which minimizes inflation.

The increasing number of crypto users not only boosts the cryptocurrencies' exchange rates and capitalization, but gradually decreases their volatility as well. Here is a rough comparison, which nonetheless illustrates the situation. Over the four years between 2010 and 2013 the BTC exchange rate changed by four orders of magnitude, while in the next four, including the dip in 2014 and the enormous bubble in 2017, it only changed by two orders of magnitude. It is true that even the modest fluctuations in 2019 are huge compared to the traditional stock and currency markets, but this is a predictable consequence of the low market cap, which is currently at around $200B. Even when taken individually, the world's largest companies like Facebook or Saudi Aramco have market caps several times that amount, while those of the global stock and currency markets have several orders of magnitude that market cap. So the current volatility of the cryptocurrencies may simply be a sign that they are still in their infancy.

Practical Evidence

There are many known cases of cryptocurrencies serving as a protective asset, primarily during national currency crises. In 2018 the national currencies of Turkey, Argentina, and Venezuela experienced drastic devaluation. While previously citizens of these countries tried to buy dollars in similar situations, this time many people turned to cryptocurrencies. As an example, in August 2018 the number of cryptocurrency users in Turkey was double the average number for Europe.

The cryptocurrencies' protection against fiat currencies' devaluation is not limited to unstable countries with only a small share on the global market. For example, statistics show that the BTC exchange rate usually increases as the Chinese yuan's rate drops.

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However, none of these examples make cryptocurrency unique. When one country's fiat currency devalues, any other country's fiat currency may serve as a protective asset if it is more stable. What makes gold unique is that its role as a protective asset is universal. Not only does it protect its owners from national currency devaluation, but from stock market crashes as well. Gold exchange rate is not particularly stable and has its own fluctuations, but it is fairly independent of stock index fluctuations. Does cryptocurrency have the same advantage? As practice shows, no.

From 2014 to 2017 BTC's exchange rate usually changed in the same direction as the indices, and often with much greater amplitude. In the fall of 2018 it briefly looked like the situation was changing. The 2017 bubble had already deflated, and the volatility of the digital assets dropped by several orders of magnitude (as it usually happens after bubbles). When American stocks started dropping in price due to the trade war with China, BTC did not follow the market's lead and had indeed served as a protective asset.

However, it was unable to cement that role. November already saw a new cryptocurrency crash that was followed by the infamous crypto winter. Whether it was chance or an expected event, it roughly coincided with the maximum dip in the stock market. The indices recovered due to the negotiations between the US and China in the spring of 2019, and so did the cryptocurrencies.

Very Risky, But Still A Protective Asset?

Overall, the properties of gold and cryptocurrencies as protective assets are very different. If you are afraid of your national currency experiencing inflation, cryptocurrency can protect your capital, but if you are a stock investor, expect cryptos to dip during a crisis as well. The reason for this is simple: despite their advantages, cryptocurrencies are still considered a very risky asset compared to securities and gold. They are exactly the assets the investors try to get rid of as soon as possible during difficult times.

Despite their advantages, cryptocurrencies are still considered a very risky asset compared to securities and gold. They are exactly the assets the investors try to get rid of as soon as possible during difficult times.

On the other hand, in the long term cryptocurrencies are still a protective asset. If you are not afraid of long exchange rate dips and are not prone to dumping all your assets during crashes, you will probably be rewarded over the years. While cryptocurrency growth on the scale of 2010-2013 is unlikely, their exchange rates are still expected to multiply in the next few years. To date, every bubble on the crypto market resulted in a substantial growth of the exchange rates. For example, the BTC rate of $3,000-4,000 during the crypto winter of 2018-2019 was vastly higher than in any year before the 2017 bubble.

The only thing that can seriously undermine the global positive trend of the cryptocurrencies is a complete ban on them by leading countries. However, this seems unlikely. With every year, more and more influential financial communities join the cryptocurrency market, and they would not want to leave it.

The increasing popularity of cryptocurrencies will eventually slow down their upward trend, but is also likely to greatly decrease their volatility and make them more similar to traditional protective assets like gold. How close that similarity would be is, as yet, unknown.

According to new research released this week by Dreyfus, a pioneer in US investing, half of individual investors (49%) have indicated they have yet to take any action to reevaluate their investment approach in light of the possibility of a shifting investment landscape, as we head into the eighth year of the economic recovery.

"As long-term risk/return expectations have shifted with an increase in inflation, the rise of US nationalism and record-low volatility, investors would be well-served to reevaluate their portfolios in light of changed circumstances to determine if they will continue to meet their investment objectives," said Mark Santero, Chief Executive Officer, The Dreyfus Corporation, a BNY Mellon company.

The "Helping Meet Investor Challenges Study" surveyed 1,250 investors with $50,000 or more in investable assets on their approach to investing. This is the first release of survey data that explores all elements of the group's investing lives, including engagement with investment professionals, portfolio allocations and appetite for risk. The study also surveyed 200 independent and institutionally-based advisors regarding the investing relationship between advisors and clients.

Older Investors Ignoring Past Market Precedents in Adjusting Portfolios

Older investors have had an opportunity to weather a variety of stock market highs, such as the bull markets from 1987-2000 and 2009 to the present, and lows, such as the savings and loan crisis in the 1980s, the stock market crash in 1987 and most recently the financial crisis of 2008. Yet, even with this past knowledge in the rearview mirror, the survey reveals:

• Sixty-one percent of investors aged 55+ indicated they have not or will not reevaluate their investment approach in today's existing investing environment.

In comparison, younger investors who experienced the 2008 market meltdown and who began their savings efforts in the earlier part of their careers demonstrated a forward-thinking approach to reevaluating their portfolios. This generation of investors between the ages of 21 and 34 indicated the following:

• Sixty-five percent had already evaluated their investment approach, compared to just 51% of those aged 35-54 and 39% of those aged 55+.
• A greater percentage of younger investors between 21-34 (63%) also indicated they had worked with an advisor in reevaluating their investments, while only a third (38%) of those 55+ had evaluated their investments with an advisor.

"Our survey revealed that younger investors have demonstrated in greater numbers a more proactive approach to reassessing their portfolios and seeking out their advisors for counsel, some of whom might lack the historical market experience and accumulated wealth of older investors," said Mark Santero.

Mass Affluent Investors Slow to Take Action on Their Portfolios

The survey also looked at the investment actions taken by mass affluent investors, those who had investable income between $250k and $2.5 million. The survey found nearly half of this audience had work to do in reviewing their portfolios and how more than a third had decided to do nothing with their portfolios:

• Forty-three percent of the total mass affluent investor audience had not reevaluated their investment approach in this new investment environment.
• Thirty-nine percent of mass affluent investors working with an advisor had not reevaluated their investment approach.

Investors Look to Advisors in Navigating the Way

Despite the last eight years of a US bull market, uncertainty is very much a reality in U.S. and global markets.

Yet a majority of investors remained on the sidelines, the survey found:

• Six in ten investors (60%) without a financial advisor are most likely to put off their plans to address today's market challenges, with only one-quarter (24%) saying that they plan to address challenges they face at some point in 2017.
• Seventeen percent said they don't have any plans to reevaluate their investment approach.

Santero added, "We believe investors who don't work with a professional advisor could greatly benefit from the insights an advisor can provide in tailoring a goals-based approach for their individual circumstances against today's investing environment of uneven economic growth. Options might include diversifying their US exposure with global fixed income and equities or considering dividend or alternative investing strategies."

Those individual investors who worked with an advisor had a greater likelihood of adjusting their portfolios. The findings revealed that:

• Almost three-quarters (65%) indicated they had reevaluated their investment approach, compared to two in five (40%) who had not worked with an advisor.
• Nearly three-quarters (73%) of advisors' clients changed their approach as a result of advice.

(Source: Dreyfus)