David Mercer, CEO of LMAX Exchange Group, which operates LMAX Digital, comments on the effects of the current trade war, currency volatility and how cryptocurrency could emerge as a ‘safe-haven’ currency.
As trade wars continue to gain momentum, creating more volatility in capital and currency markets, many are looking for alternative options to ensure they can maintain the value of their investments. During these times, people tend to go to the so-called ‘safe-havens’.
In the past, ‘safe-haven’ status has been attributed to gold, considered as an archaic standard with no intrinsic value by many. Although still at a nascent stage, people and institutions are starting to view cryptocurrencies as a store of value.
One of the benefits of cryptocurrency is that it has a limited supply, which protects the intrinsic value of the currency. This characteristic means that cryptocurrency has the potential to emerge as a new safe-haven asset. However, legislative, regulatory and liquidity issues need to be addressed before crypto achieves widespread adoption among both, retail and institutional markets.
Strategic trade wars
The world’s largest economies, US and China, have locked horns, igniting what is showing signs of escalating into a full-blown trade war. Fear of the broader ramifications of these tensions have been widely reported with real and detrimental impact predicted for global economies and investors.
In order to understand the effects of the current trade war that has stricken the global economy, it is important to first understand why governments impose trade tariffs.
The US is at the forefront of the trade tariff dilemma. The main strategy behind imposing these tariffs is to enact a ‘weak dollar policy’. This is a well-trodden path during times of economic distress and financial crisis, which sees governments attempt to bring down the value of domestic currency to make exports cheaper, while imposing tariffs on imports to rebalance the economy.
Dating back to the 2008 crisis, the US Federal Reserve has consistently intervened, artificially boosting the economy, with no exit plan. The idea was to further balance out the US deficit by creating a barrier to foreign imports. The US has a vast trade deficit as it is a massive consumer-driven economy and sources many products desired by consumers from abroad.
In theory, the introduction of trade tariffs, coupled with dovish monetary policies, such as lower interest rates, should temporarily boost the economy. If the currency weakens, the US economy can strengthen.
The race for the weakest currency causes detrimental effects
The problem with this strategy is that what was meant to be a temporary boost while the economy recovered, is still ongoing. The Fed has recklessly incentivised a one-way trade into the stock market for over a decade.
What is left is an inflated stock market falsely promising hope for citizens. Average disposable income is increasing due to longer working hours and rising employment levels, whilst real wages themselves have not gone up and housing prices continue to increase. This is causing consumers to lose trust in the central government intervention policies.
Investors have come to expect record stock market highs in the US, leaving them over-exposed when news of a negative downside risk shock occurs. This increases the potential for radical market movements.
When stabilising the economy, the US has driven many global powers into a race to weaken their respective currencies – no one wants to have currency appreciation. The European Central Bank is lashing out at the US President for threatening sanctions because they want to avoid an appreciation of the Euro; the Bank of Japan and the Swiss National Bank are following suit to avoid an appreciation of the Japanese Yen and the Swiss Franc.
The US set the wheels in motion and now all the competitive central banks are pumping money into their respective economies, in the race not to be left with the most expensive currency. Now the trade war looks to be escalating, deflationary pressures are resulting in unprecedented currency volatility and risk.
The search for a ‘safe-haven’
With all this uncertainty in the market, more common in emerging economies but less so in developed markets, people are feeling the pressure and becoming worried about the lack of protection for the value of their savings. Investors are wary that the consistent equity market highs will plateau, while consumers are conscious that this economic prosperity isn’t trickling down into their pockets.
The search for a ‘safe-haven’ currency has begun. Historically, gold was always viewed as the stable currency because there is only a limited amount of it in the world and central governments cannot simply print new gold.
Cryptocurrency has been built on the same principle and may provide a more legitimate option. As gold, only a limited number of coins are available for trade. However, by using blockchain technology cryptocurrency adds another layer of protection that allows for a detailed trail of all trading history. So why aren’t investors and consumers rushing to digital currencies in times like this?
In order to understand this, it’s important to take a step out of the West and into the East, where consumers have been crippled by continuous volatility and have adopted cryptocurrency as a ‘safe-haven’ for their hard-earned money for years.
Dating back to when cryptocurrency first entered the market in 2009, many migrant workers were reliant on sending the profits of their labour back to family members. For example, these workers would make the equivalent of £3 an hour and deposit the money into their bank.
At the end of the week, when they went to send the money home to their families, they would discover that their money was worth next to nothing as the exchange rate had dipped massively. By this point they stopped trusting governments to tell them how much their money was worth and sought different options. Cryptocurrency became the obvious means to pass on their savings to family members.
With a limited amount of coins protecting the value of their money, these migrant workers could take comfort in getting paid in cryptocurrency and knowing that the government could not strip them of its worth.
Fast forward to modern day and cryptocurrency is now accepted widely in most Asian countries. So why is the use of digital currencies in the West not widely spread? And why would anyone choose to get paid in a currency that is ultimately controlled by a governing body and can change at any instance?
What needs to change?
Western societies are now becoming accustomed to currency volatility and are finding themselves in a similar predicament to the migrant workers touched on earlier. The idea that there is a currency that is uncorrelated to government intervention seems comforting, yet the mentality of western cultures still deems this as unsafe due to lack of regulation.
One of the major reasons why the transition into digital currencies hasn’t happened quite as quickly in the West is the number of barriers blocking crypto from being readily accepted.
In order to overcome these barriers, cryptocurrency has to become crystallised as an asset class and institutions will need to begin investing a portion of their portfolio in cryptocurrency as well as actively trading it on crypto exchanges.
For this process to take place, an established internationally trusted marketplace needs to be in place to enable institutional cryptocurrency trading. This hinges on the provision of credit by the banking system, which is at odds with the inspiration behind the Satoshi Nakamoto whitepaper, the paper that was the precursor to Bitcoin. Credit plays an important role in providing traditional fund managers or hedge funds with the funds to execute their trading strategies.
At the moment, credit – the oil that greases the wheels of institutional finance -is grossly absent in cryptocurrencies.
The next step is the implementation of proper regulation, to both, protect the retail consumers and to get institutions comfortable to operate in this marketplace. Once consumers and their coins are protected, institutional players can self-regulate the market. It will be essential for institutions to trade digital currency according to international norms.
Another barrier is the lack of liquidity. But this problem is easier to solve as institutions can resolve this issue by bringing in capital and helping create a more fluid market.
Lastly, the lack of infrastructure needed for sourcing cryptocurrency is another barrier. As they stand, digital currencies are massively expensive to produce due to their energy consumption and because there is no way to efficiently mine units. As more players try to enter the industry, the funding will come, enabling proper, more efficient infrastructure to be built.
The time is now
The world is frustrated with government and central bank intervention and is thirsty for another way in which they can hold and maintain the value of their assets. People need a way to protect the value of their money, regardless of the level of central bank manipulation and intervention.
Cryptocurrency has the framework and ideology to emerge as a ‘safe-haven’ currency in such volatile times, but there are large roadblocks in the way. If some of these barriers can be resolved to encourage institutional investment in digital assets, the world benefit from an alternative asset in which to park their money, or a ‘safe-haven’.
By David Mercer, CEO of LMAX Exchange Group, which operates multiple institutional exchanges for FX and crypto currency trading. LMAX Digital is the Group’s cryptocurrency exchange that focuses on institutional investors only.
Cryptocurrencies: the new gold?
By Gerald Moser, Chief Market Strategist, Barclays Private Bank
Time to add to a portfolio?
There has been a lot of talk about bitcoin, and cryptocurrencies in general, being a “digital” gold. Similar to gold, there is a finite amount, it is not backed by any sovereign and no single-entity controls its production. But for bitcoin to be considered in a portfolio and to become an investable asset, similar to gold, the asset would need to improve the risk/return profile of that portfolio. This seems a tall order.
While it is nigh on impossible to forecast an expected return for bitcoin, its volatility makes the asset almost “uninvestable” from a portfolio perspective. With spikes in volatility that are multiples of that typically experienced by risk assets such as equities or oil, many would probably throw the cryptocurrency out of any portfolio in a typical mean-variance optimisation.
And while bitcoin’s correlation measures are relatively supportive, it seems to falter when diversification is most needed, such as during sharp downturns in financial markets. Looking at weekly return correlations since 2016 shows that bitcoin is not strongly correlated with any assets (see below). It is however only second to US high yield in its correlation with equities. US Treasuries, gold and US investment grade were better diversifiers than bitcoin when it comes to equities.
Furthermore, looking at global equity corrections since 2015 (see below), it is noticeable that bitcoin has performed even worse than equities over the last three corrections. And while gold and fixed income provided some relief during those corrections, bitcoin compounded the loss that investors would have incurred from equities exposure.
The fact that cryptocurrencies also fluctuate alongside equities suggests that investment in bitcoin is more akin to a bubble phenomenon rather than a rational, long-term investment decision. The performance of the cryptocurrency has been mostly driven by retail investors joining a seemingly unsustainable rally rather than institutional money investing on a long-term basis.
Several studies around market structure have shown that emerging markets with high retail/low institutional participation are more unstable and more likely subject to financial bubbles than mature markets with institutional participation. And while more leading financial houses seem to be taking an interest in cryptocurrencies, the market’s behaviour suggests that the level of institutional involvement is still limited. Another issue is around its concentration: about 2% of bitcoin accounts control 95% of all bitcoins.
In summary, difficulty to forecast return, lack of diversification and high volatility makes it hard to consider bitcoin as a standalone asset in a diversified portfolio for long-term investors.
An inflation hedge?
Another point widely quoted in favour of cryptocurrencies is that they provide an inflation hedge. This might be a valid point, if inflation stems from fiat currency debasement. As mentioned above, a currency’s worth comes from the trust economic agents have in it. If unsustainable amounts of debt and large money creation shatter belief in sovereign-backed currencies through spiralling inflation, cryptocurrencies could be seen as an alternative.
Regardless of its price, bitcoin’s production is set on a precise schedule and cannot be changed. If oil or copper prices go up, there is an incentive to produce more. This is not the case for cryptocurrencies. In a very specific and highly hypothetical scenario of all fiat currency collapsing, this could be positive. But other real assets such as precious metals, inflation-linked bonds or real estate usually provide a hedge against inflation.
Bitcoin’s technology should theoretically make it extremely secure. As there is no intermediary, each transaction is reviewed by a large number of participants which can all certify the transaction. However, there have been frauds and thefts from exchanges. Another point to consider is the risk of “losing” bitcoins. According to the cryptocurrency data firm Chainanalysis, around 20% of the existing 18.5m bitcoins are lost or stranded in wallets, with no mean of being recovered. As there is no intermediary, there is no backup for a lost bitcoin.
From a sustainability point of view, adding cryptocurrencies to a portfolio will make it less green. Mining and exchanging them is highly energy intensive. According to estimates published by Alex de Vries, data scientist at the Dutch Central Bank, the bitcoin mining network possibly consumed as much in 2018 as the electricity consumed by a country like Switzerland. This translates to an average carbon footprint per transaction in the range of 230-360kg of CO2. In comparison, the average carbon footprint of a VISA transaction is 0.4g of CO2.
Beyond energy use, the mining process generates a large amount of electronic waste (e-waste). As mining requires a growing amount of computational power, the study estimates that mining equipment becomes obsolete every 18 months. The study suggests that the bitcoin industry generates an annual amount of e-waste similar to a country like Luxembourg.
Cryptocurrencies are here to stay
Innovation in digital assets continues rapidly and will likely drive increased participation, both from retail and institutional investors. The underlying blockchain technology behind bitcoin was meant to disrupt a few different industries. While results have not lived up to the initial hype, more sectors are investigating the use of the technology.
And with Facebook announcing a stablecoin, or a cryptocurrency pegged to a basket of different fiat currencies, central banks have accelerated the movement towards central bank digital currencies. Those could improve payment systems resilience and facilitate cross-border payments.
Energy stocks drag down FTSE 100, IG Group slides
By Shivani Kumaresan
(Reuters) – London’s FTSE 100 slipped on Thursday, weighed down by falls in energy stocks as oil prices slid after a surprise increase in U.S. crude inventories, while IG Group tumbled on plans to buy U.S. trading platform tastytrade for $1 billion.
The blue-chip FTSE 100 index lost 0.4%, while the domestically focussed mid-cap FTSE 250 index also slid 0.4%.
Energy majors BP and Royal Dutch Shell fell 3.2% and 2.5%, respectively, and were the biggest drags on the FTSE-100 index. [O/R]
“What is holding back the UK is a lack of tech stocks to capture the ‘rotation’ back into tech seen since Netflix results,” said Chris Beauchamp, chief market analyst at IG.
“Stock markets overall are much quieter today, looking so far in vain for a new catalyst for further upside.”
The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy and led to mass layoffs.
British Prime Minister Boris Johnson said it was too early to say when the national coronavirus lockdown in England would end, as daily deaths from COVID-19 reach new highs and hospitals become increasingly stretched.
IG Group tumbled 8.5% after announcing plans to buy tastytrade, venturing into North America after a stellar year for the new breed of retail investment brokerages.
Ibstock jumped 7.3% to the top of the FTSE 250 after the company said fourth-quarter activity benefited from better-than-expected demand for new houses and repairs.
Pets at Home Group Plc rose 2.2% after reporting an 18% jump in third-quarter revenue, boosted by higher demand for its accessories and veterinary services as more people adopted pets during lockdowns.
(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V and Mark Potter)
Wall Street bounce, upbeat earnings lift European stocks
By Amal S and Sruthi Shankar
(Reuters) – European stocks rose on Wednesday after Dutch chip equipment maker ASML and Swiss luxury group Richemont gave encouraging earnings updates, while investors hoped for a large U.S. stimulus plan as Joe Biden was sworn in as president.
The pan-European STOXX 600 index closed 0.7% higher, getting an extra boost as Wall Street marked record highs.
All eyes were on Biden’s inauguration as the 46th U.S. President, with traders betting on a bigger pandemic relief plan and higher infrastructure spending under the new administration to boost the pandemic-stricken economy.
Tech stocks rallied to a two-decade peak in Europe after ASML Holding NV rose 3.0% to all-time highs on better-than-expected quarterly sales and a strong order intake for 2021.
Meanwhile, Richemont rose 2.8%, after posting a 5% increase in quarterly sales as Chinese splashed out on Cartier, its flagship jewellery brand.
Britain’s Burberry jumped 3.9% after it stuck to its full-year goals, saying higher full-price sales would boost annual margins, while Asian demand remained strong.
The pair boosted European luxury goods makers that are heavily reliant on China, with LVMH and Kering gaining between 1% and 3%.
“Any sign that retail spending is picking up in China is going to be a boost to the Western markets and those heavily exposed to it,” said Connor Campbell, financial analyst at SpreadEx.
The European Central Bank is set to meet on Thursday. While no policy changes are expected, the bank could face more questions about an increasingly challenging outlook only a month after it unleashed fresh stimulus to bolster the euro zone economy.
“With the new round of easing measures fully in place and no new forecasts to be presented tomorrow, it should be a fairly uneventful day for the euro,” ING analysts said in a note.
Italy’s FTSE MIB gained 0.9% and lenders rose 1.6% after Prime Minister Giuseppe Conte won a confidence vote in the upper house Senate and averted a government collapse.
Conte narrowly secured the vote on Tuesday, allowing him to remain in office after a junior partner quit his coalition last week in the midst of the COVID-19 pandemic.
Daimler AG jumped 4.2% after its Mercedes-Benz brand unveiled a new electric compact SUV, the EQA, as part of plans to take on rival Tesla Inc.
Germany’s Hugo Boss added 4.4% after Mike Ashley-led Frasers said it boosted its stake in the company.
(Reporting by Sruthi Shankar and Amal S in Bengaluru; Editing by Shailesh Kuber and Arun Koyyur and Kirsten Donovan)
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