Bitcoin: digital insulation from sovereign risk?

Alex Constantinou & Linton Reddy

Well, to answer our own question, it depends. Currencies in common use such as Euros, Dollars and Rands for example, are all considered fiat (i.e. by decree) currencies. As such, they are backed by each respective country’s central bank and government, and regulated by the central authority of these institutions. Bitcoin on the other hand operates autonomously, and is instead based on a hard-coded mathematical algorithm which allows for distributed decentralised consensus on the ownership and transfer of value. The technology removes the necessity for any institution to place itself in between the transfer of value from one party to another, and achieves this through its verifiable distributed public ledger (otherwise known as a blockchain).[1]

We won’t go into the details here on how this works from a technical perspective, suffice to say that at present, the Bitcoin blockchain has been around for nearly a decade with a single Bitcoin (BTC) valued at R9,620 as of the time of writing.[2] The absence of backing by a regulatory authority is arguably counterbalanced by the fact that Bitcoin is not exposed to sovereign risk in the way that fiat currencies are, and thus offers a haven from such sovereign risk.

Based on Bitcoin trading data since 2013, the evidence on its pricing in that time does appear to show that, when there is increased uncertainty associated with global macroeconomic and financial stability, the volume of Bitcoin trading and its USD price do seem to increase. It thus does seem to already have been used as a safe haven in a number of circumstances. To this end we observe some selected events in Figure 1 below.

Figure 1: Global market price of Bitcoin in U.S Dollars, Jan 2013 – Oct 2016

* Smoothing constant of α = 0,1 has been applied as a visual aid. Therefore, the secondary axis is not the actual volumes traded but still a good indication of the movements in volume traded.

Source: DNA Economics using data from Blockchain Luxembourg S.A.R.L, 2016[3]

In March 2013, the Cypriot government imposed capital controls to prevent a run on the banks following the banking crisis in Cyprus, which finds its origin in a debt crisis that “started to shake the world’s financial markets”[4]. As noted by some commentators around the time of the Cypriot banking crisis:

“The online alternative currency [Bitcoin], previously little more than a curiosity in financial markets since its 2009 inception, has zoomed in trading value since the Cyprus banking crisis erupted two weeks ago. With fears spreading that even insured deposits might not be safe in similar nations hit by banking crises, those looking for a haven to store their wealth have fled to the complicated world of digital cash.”[5]

“…In March-April 2013, when Cyprus clamped down on bank withdrawals, bitcoin rocketed…[6]”

In August 2015, China begun significantly devaluing their currency (the Yuan) which appeared to spark fears of a loss in purchasing power, resulting in a rise in the value of Bitcoin:

“The People’s Bank of China (PBOC) sharply devalued the Chinese yuan in August 2015. This move triggered bitcoin’s breakout, said Hayes, as the central bank kept reducing the value of China’s currency over the next 10 months. Bitcoin benefited from “fears of Chinese savers that their purchasing power would drastically decrease,” he stated.”[7]

Finally, towards the end of May and beginning of June 2016, uncertainty surrounding Brexit began as polling at the time showed voters leaning toward leaving the European Union (EU):

“Public opinion has shifted towards the UK leaving the EU, two Guardian/ICM polls suggest as the referendum campaign picks up pace – with voters split 52% -48% in favour of Brexit, whether surveyed online or by phone.”[8]

And finally, once the final referendum decision was reached which resulted in Britain leaving the EU, analysts pointed toward Brexit for the possible reason behind the surge in value of Bitcoin:

“Algorithmic trader Jacob Eliosoff also weighed in on the situation, stating that the Brexit probably boosted bitcoin…”[9]

There is thus a fair amount of evidence that Bitcoin has been used as a safe haven in a number of instances. Having observed the global market, we now turn to South Africa for a look at Bitcoin exchange behaviour around the time of selected domestic macroeconomic and financial events, illustrated in Figure 2 below.

Figure 2: Price and volume of Bitcoin (ZAR), Oct 2015 – Oct 2016

Source: DNA Economics using data from BitX South Africa, selected period of 1 year.

As shown in Figure 2 above there are three significant macroeconomic events which serve as useful markers to observe. These occurred where there was a simultaneous increase in domestic exchange trade volume and a commensurate rise in the ZAR value of BTC. We utilise publically available trading data from the local BitX exchange in South Africa, on the assumption that a fairly significant proportion of South African bitcoin trade occurs on this exchange.[10]

In late October 2015, the rand fell sharply by almost 2% on the back of the Medium-Term Budget policy statement delivered by (the then) Finance Minister Nene amid vocal protestation outside Parliament regarding “poor policy formulation and lack of implementation”[11]; the bleak outlook for the economy was evidenced by the cut in the growth forecast from 2% to 1.5%. In addition to this, tax revenue projections were forecast to decline by R35bn over the next three years.[12] As stated by Rian le Roux, chief economist at Old Mutual Investment Group in Cape Town:

“The government is now tightly stuck between the slowing economy – and tax revenue growth – and spending pressures, emanating from social-spending pressures, a rapidly growing wage bill and surging debt-service costs…”[13] [own emphasis]

Simultaneously, South Africa faced credit downgrade risks, with the take of the credit rating agencies on the local economy being that “South Africa and Indonesia are primarily exposed to financial market turbulence through their trade links with China and a period of low commodity prices”.[14] Finally, towards the end of October 2015 possible US rate hikes threatened to impact on the local market, as detailed by the SARB:

“South Africa’s high external financing requirements make the country vulnerable to the possibility of market volatility, which is associated with increases in US policy rates… This could raise foreign-exchange related risks and increase the prospects of capital-flow reversal as investors become wary of exposures to volatile and vulnerable currencies…”[15]

This pattern is observed again in early December 2015 when news of a 4% current account shortfall spread creating further pressure on the rand “…The current account deficit widened sharply in the third quarter of this year, Reserve Bank data showed on Tuesday [8 Dec 2015], signalling further pressure on the rand.”[16] Compounding this, the next day, on 9 December 2015, Minister Nene was fired in a shock announcement that saw a 5.8%[17] drop in the value of the Rand relative to the US dollar over the next two days.[18]

“In a shocking move that saw the rand plummeting to below R15 to the US dollar, Zuma appointed a relatively unknown backbencher David ‘Des’ van Rooyen – who served as a member of the finance committee in Parliament – to replace Nene.”[19]

Regarding the impact of Brexit in South Africa, there is a clear, although less pronounced impact. The local price of Bitcoin on 19 May 2016 was R7,429 and by 16 June 2016 was R9,876 (24.7% change), while global exchanges saw the price move from $448 to $761 (41.1% change) for the same period. This in some part highlights SA’s insulation against the uncertainty created in the EU as the higher delta indicates that global markets responded more sharply than local markets.

Thus, it appears that even locally, news associated with macroeconomic and financial instability sees a commensurate uptick in BTC trading volume with investor funds flowing into the digital asset. Whilst we cannot account for or quantify the precise impact of the various announcements on the total volumes traded (across all platforms), what we do observe is that the trend in trade volume of bitcoins exhibits a sharp increase in the face of impending macroeconomic risk factors. This suggests to us that, thus far, bitcoins are being used as a safe-haven by local investors, albeit to a more limited extent than seen internationally. It will be interesting to see if the local market begins to track international behaviour more closely over time.