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Should I Invest in Cryptocurrency in a Recession?

1. Introduction

Cryptocurrencies have allured a great deal of attention, further taking the economical world by storm. With there being no well-defined view of exactly what cryptocurrency is, it has been stated and described as a digital or virtual currency that uses cryptography for security. With cryptography being the art of writing and solving codes, it is fairly obvious as to why this factor has appealed to many people seeking a private, secure form of transferring money. An aspect of cryptocurrencies that all must know is that they are not issued by a central authority, making them theoretically immune to interference or control from any other form of government or entity. Although this may sound a little too good to be true, if it looks like a duck and quacks like a duck, the chances are it is a duck. Cryptocurrencies lack leadership and, most importantly, a set of rules, which explains why there are over 500 different varieties of cryptocurrencies. Bitcoin is the first and most extraordinary variety of cryptocurrency. It managed to peak the interest of people from all over the world and also gained significant media attention. It is also the face of current cryptocurrencies. When many think of cryptocurrency, they instantly think of Bitcoin. This could be because a lot of society today are followers of brands, hence iPhones, iPods, Facebook, and McDonald's. Coming 2nd is never a good feeling. Although that was a little off-topic, it will not be surprising if it was discovered that a considerable number of people do not even know that there are indeed other cryptocurrencies other than Bitcoin.

1.1 Benefits of Investing in Cryptocurrency during a Recession

A further consequence of economic downturn is the increased activity of central banks printing money to try to stimulate the economy. This can have the indirect effect of devaluing fiat currencies, especially if done in an uncontrolled way. With Quantitative Easing, the effect is similar to that of flooding the market with a centralized asset. As incoming and existing investors in precious metals are attracted by higher prices, increased speculation, and investment. With these factors combined, there is an increase in the relative cost of holding cash. That is, the trade-off between forgoing interest to reduce risk and return on a speculative investment is lower. This essentially creates a stronger demand for holding money in interest-paying or interest-yielding assets. With the lending market full of risk and credit constrained, the thinnest version of higher interest-yielding assets would be long-dated government bonds. Since the cost of borrowing in a specific currency is comparative to that language's short-term interest rates, foreign exchange known as the carry trade, is simultaneously buying and selling currencies with differing interest rates will be diverted into said currency of interest to purchase bonds on the expectation for a return due to interest rate differential. This will further increase the demand for the interest-yielding currency. Long story short, there will be increased global demand for precious metals and speculative investments. Step in cryptocurrency.

Cryptocurrency might offer a way during recessions. With economic uncertainty making it difficult to predict traditional asset classes, many self-directed investors turn to non-traditional ways to grow their money or simply keep what they have got. In times of crisis, when interest rates are very low, safe savings havens such as savings accounts and term deposits are very low yielding and if inflation is factored in, provide negative real rates of return. This means that the value of money deposited in these kinds of accounts is actually decreasing.

1.2 Risks of Investing in Cryptocurrency during a Recession

A decentralised technology with low barriers to entry is the perfect environment for scams and get rich quick schemes. The cryptocurrency market has no shortage of new and innovative ways to scam people; recently there was one where a "company" promised to double your Ethereum. Doubling money is something that is akin to a holy grail; it is viewed as maximum liquidity with minimum effort and is something that people who are desperate for cash will jump at. Dupe 1:1000x leveraged forex trading is another holy grail gamble, and this is an activity that is rampant during economic booms and busts due to the gambling nature and the fact that it can make or lose large amounts of money in a short period of time. Cryptocurrency is a means to this end for forex traders due to the 24/7 nature of the forex market and its high liquidity nature. Many of the people who have made significant losses in forex and possible are looking to recoup their losses in a risky fashion.

During recessions, people look to make money any way possible and often do so through get rich quick schemes and gambling, resulting in an increased liquidity demand for relatively high risk and high return investments. Cryptocurrency is perfect for this environment, since it's entirely global and the barrier to entry is low. This has resulted in some relentless speculation and price volatility as can be seen by the broad upward trend in altcoin trading volume and prices. This rampant speculation has led to a large amount of people buying cryptocurrency with the expectation of making easy money, thus an increase in the percentage of weak hands. In finance, the term "weak hands" refers to people who have a weak grasp on the fundamental principles of an investment and are simply looking to get rich quick, they are the last to buy and first to sell, thus they are the people who generally get burned. The increase in weak handed investment in cryptocurrency has partially caused the absolutely ridiculous levels of market cap and valuations that we are seeing in the current market. This is dangerous, as it is a ticking time bomb; a rapid devaluation in the wake of a lessening in speculation.

Investing in cryptocurrency carries a high level of risk and can result in the loss of all of your investment. Many proponents of cryptocurrency argue that it is a "safe haven" asset, much like gold, and can be used as a hedge against traditional fiat currencies. They argue that in an uncertain economic climate, a fiat currency that is backed by nothing is a recipe for inflation and general instability and note that cryptocurrency has a fixed supply, thus it cannot be devalued by political decisions regarding issuance. While this point is entirely valid, it does not in any way mitigate the risk inherent in the current speculative fever surrounding cryptocurrency.

2. Best Cryptocurrencies for a Recession

When considering to buy Bitcoin during a recession, one should use the method of dollar-cost averaging (DCA). DCA is an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase. With DCA you are not trying to time the market, and this is a strategy that should be used by retail investors who are unaware of the volatility of the cryptocurrency market. Given that cryptocurrencies are prone to major fluctuations in prices, this is the most efficient method to buy Bitcoin in small amounts at different times and still get an average price that is manageable. Simulation studies have shown DCA strategies to outperform 66% of the time to buying the total amount of an asset at its current value. This is the perfect index to assess the comparative benefits of this strategy and it is definitely one where it's beneficial to set and forget.

In a recent podcast conducted by Anthony Pompliano, Co-founder of Morgan Creek Digital, and the renowned gold bug, Peter Schiff, they had an interesting debate regarding Bitcoin and gold within the economic climate surrounding the COVID-19 pandemic. Schiff has always been known as a major advocate for gold, even against Bitcoin. However, the two came to an agreement that as a newer market, Bitcoin should be considered a safer asset in comparison to gold in the midst of an economic downturn. This is due to the fact that stockpiles of gold are abundant whilst gold itself is at the beginning stages of a bull rally recently reaching an all-time high in price. Bitcoin has a fixed current supply and its scarcity is constantly increasing until it hits the 21 million maximum supply in the year 2140. Simulation studies have shown that Bitcoin will move from being a risk asset to a hedge asset throughout various macroeconomic environments. The pioneer cryptocurrency would be a good investment in an economic downturn, and still has massive potential upside. Although, it would not yet be as beneficial to attain large sums of Bitcoin through buying on the spot due to its speculative nature.

As an investor, you want to focus on your potential returns. To do so, it’s important to be intelligent in your decision of which crypto to invest in. Historically, certain cryptocurrencies have stood out in comparison to others during a financial crisis. The two main standouts have been Bitcoin and gold.

2.1 Safe Haven Cryptos for Economic Downturns

Once again, much like the study into the best financial asset to have in a recession, only the most robust assets will be viable destinations for a safe haven investment. If these hedge assets are to provide a counter-cyclical investment opportunity, they should not be directly or highly correlated with the traditional assets that are being avoided. This is to prevent the safe haven asset taking on the same systematic risk as the depreciating assets, as seen in the appreciation of US treasury bonds despite Standard and Poor's downgrade of their credit rating in 2011 (FT, 2017). Given that the effects of cryptos are still in a relative infancy stage and there are fewer appropriate large-scale data analysis tools, there is no quantitative evidence of crypto asset correlation with stocks and other conventional financial assets. However, during the COVID crash of February-March 2020, seasoned bitcoin investors purported the coin to be a store of value and thus a safe haven investment, as gold has historically been considered. This claim was supported by the UK financial regulator classifying the risk of investing in bitcoin as smaller than investing in certain equity funds and spread betting (FT, 2020). Although gold itself is considered an essential safe haven asset for wealth storage, its near video game-like performance in an economic crisis is not suitable for the investor looking to purchase gold-backed crypto.

2.2 Dollar-Cost Averaging Strategy for Crypto Investments in a Recession

With the normal market timers hypothesis, investors can purchase cryptocurrencies in a recession. The more you trust the cryptocurrency will have future value, the more money you can set aside and contribute during the recession. The concern with this methodology is pinpointing the base of the market and it requires lots of efforts to routinely monitor the investment. Dollar-cost averaging (DCA) is an investment strategy focused on the preference shares of an investment and its total value. Investors using this method will split the total sums of money to be invested into periodic investments of the same amounts. By following this strategy, it will give the ability to buy more cryptocurrency when the cost is low and when the cost is high, it will buy less. This type of investment framework permits to reduce the effects of digital money unpredictability and investor's bias to buy more cryptocurrency when it's overestimated and less when it's underestimated. DCA is best executed by purchasing on a schedule (for example, once per week or once per month) and involves rebalancing of other investments to have new cash flow to split into future investments. This methodology makes it simpler to assess investment performance, to alter investment sums, and to adjust to the potential higher/future value of investment in cryptocurrency. In addition to this, the low liquidity in cryptocurrency markets contrasted with stock and forex markets means DCA could have a greater impact on cryptocurrency prices during a recession, as the sum of periodic purchases might be more significant to the volume being traded at the time.

3. Protecting Your Crypto Portfolio during a Recession

For those who do not require immediate access to funds, the smart money is on trying to avoid touching the principal for as long as possible. This means very different things depending on the size of your portfolio, from taking a hiatus on further investment, to adjusting your spending habits and putting off major purchases. If you are unsure about the future status of your job and income, it may be best to look into a DeFi platform where you can discipline yourself to locking away a fixed amount of crypto in exchange for periodic payments. This can serve as a mode of forced saving with a higher future value and unlike traditional credit, it will not carry high interest rates and fees.

When a recession strikes, your action plan should depend on what stage of life you are at, as this will greatly impact your options and any constraints that you may face. For those who need to liquidate some of their cryptocurrency to pay the bills, there truly is no alternative to converting it into fiat, and this should preferably be done when the conditions are still constructive. If you have significant tax liabilities, it may make sense to hastily realize capital gains so that your losses can offset these. This direct approach is not for everyone though and definitely carries some risks. If your profession and skills are in IT, it may be worthwhile to start looking for job opportunities in countries where cryptocurrency is more widely accepted and integrated.

3.1 Financial Planning Strategies for a Recession

Owning crypto in a deflationary market can also mean the opportunity to pay off large future debts with a smaller cost in today's money. This is essentially "shorting" what you owe. For example, if you know that in 3 years' time you'll owe 100k on a mortgage, it may be wise to invest 20-30k of that money in crypto. Should the investment yield a profit or even a debt, 20-30k could pay it off.

Cryptocurrency can be a high-risk form of investment. There are often many new investors who speculate on asset prices, with the hope of making a quick profit. Those who have purchased crypto as a quick gap to make large gains could use loss of employment as a reason to pull money out of investments to sustain living costs. This selling of assets usually drives the price down due to increased supply and can lead to missed opportunity or a negative return for the seller. This is a scenario where good financial planning will ensure you don't have to sell assets in tough market conditions.

Financial planning is crucial when considering a recession eventuating. Unexpected loss of employment is an eventuality many people face during a recession. As a general rule of thumb, it is recommended to have 3 months' salary saved in case an event like this occurs. Obviously, the longer the projected recession, the longer an individual should aim to sustain living without an income. Loss of employment will also increase competition for new job opportunities, which can mean potential income is also reduced.

3.2 Alternative Investments to Consider during a Recession

Overall, the parallel financial system that cryptocurrency would operate in during a recession could see it outperform national currencies under similar circumstances, but it would face the very same market pressures with potential for even less experienced or prepared institutions operating in a more hostile environment. The attempt to bring its rally onto more stable and traditional forms of money make it a less risky and more easily reversed transaction through increased effective demand and speculative activity. It would be at this point that an oversold cryptocurrency would face the effects of monetary inflation and a less liquid form of the traditional money it attempts to replace.

Investors would find it hard to retrieve their money from a potential "failed" investment as it may result in banks and debtor countries instructing restriction of capital outflows and impose exchange controls as an emergency measure to stop money leaving the country and precious metals and stones being smuggled out. If exchange controls are thorough and rigorously enforced, it could cause serious shortage of foreign currency and exchange rate to be overvalued. The duration and severity of capital and exchange control are closely tied to currency black markets, which often develop into a significant source of unanticipated revenue during a period of economic volatility. In contemporary international finance, a new and unregulated form of currency such as cryptocurrency could easily be traded on the black market and sold for a much higher price than its true value. This is usually done in anticipation of currency revaluation and any success in manipulating rates of exchange during an economic crisis could result in the depreciation of local currency value and exacerbation of inflation. These phenomena would all directly affect the exchange of cryptocurrency to foreign currency and traditional commodities.

Certainly, cryptocurrency wouldn't be the most suitable investment during a recession. Even with a change in currency form, this method of investment will face the effects of economic recession. Efforts to convert cryptocurrency into more stable forms of money to alleviate some effects of recession will prove difficult.

4. Comparing Gold and Cryptocurrency in a Recession

Gold is often considered a bad investment in healthy economic times. The reasoning for this is that the price of gold has a negative correlation with the stock market. This means that when stocks are selling well, the price of gold is likely to increase, and when the stock market is slumping, the price of gold will decrease. Given then that the best time to invest in gold is when it is at its lowest in relation to the cost of stock, if you were to invest in gold, you would have to buy when the price is high with the hopes to sell further in the future for a profit. In the short term then, investing in gold is a bad idea in times of economic downturn. This is true despite the fact that gold retains its value well over time. A person thinking of investing in gold during a recession will have to think long term and wait to sell until the price of gold has returned to a high in relation to the stock market. This may take many years due to the volatility in today's world. This is shown by the fact that the price of gold doubled while the stock market was recovering from the recession of the mid-70s. However, it did not reach another high in relation to the cost of stock for nearly 25 years. Investing in gold is likely not an ideal short-term investment for anyone in need of money at the present time.

In economic times of recession, it is often the best time to invest as much money as you can spare, so as to obtain the highest long-term return on your investment. The choice will be where to put the investment you have decided to make, and for those seeking a safe investment, it is likely they have considered an investment in gold. Gold has long been considered a safe choice for investment in times of economic downturn, however, it is debatable whether cryptocurrency deserves that reputation in today's world. This article is aimed at considering an investment in both gold and cryptocurrency (such as Bitcoin) and comparing the two as an investment to see which is the best in terms of return on investment at the end of an economic downturn.

4.1 Pros and Cons of Investing in Gold during Economic Downturns

Gold is known as a safe haven for investors. It is a form of wealth and store of value and is therefore a popular choice in times of economic crisis. During the global economic downturn of 2008, the price of gold was relatively stable, with prices ranging from $720 an ounce to $980 an ounce from the beginning to the end of the year. In subsequent years, the value of gold has increased drastically. This is indicative of gold's tendency to hold or increase in worth during periods of economic hardship. During the 2008 recession, the global demand for gold increased 15% from the previous year, with most of this demand coming from the investment sector. With increased investment in gold and gold products at an all-time high, it is evident that gold is attractive to investors in times of economic downturn. This makes for a fairly strong argument for gold as a safe investment when the economy is not looking too healthy. By contrast, investing in an unstable or relatively new currency such as cryptocurrency is likely a greater risk as there is no evidence of them holding value in the long-term, let alone in times of economic crisis. With large unemployment rates and lower incoming and discretionary spending in tough economic climates, jewelry and gold products are deemed as non-essential luxury items and as such, the demand for gold to produce these items is likely to decrease. This occurring in a time where the demand and price for gold is increasing could result in there being less gold in the market and inflated prices which will have a negative effect further down the line for the gold industry and its consumers.

4.2 Pros and Cons of Investing in Cryptocurrency during Economic Downturns

During economic downturns, the main benefits of cryptocurrency do not shine through. There is no opportunity for speculation through the rise of cryptocurrency, as the coins are seen to be highly volatile, and a bear market of recession sees them decrease in value dramatically. The seignorage effect is not felt within cryptocurrency either. An increase in money supply does not drive up prices as the majority of cryptocurrencies have a predetermined issuance rate. In the case of Bitcoin, the supply is capped so seignorage would not be applicable. This is both a positive and a negative for investing in cryptocurrency. The positive being that with the predetermined issuance rate, cryptocurrencies are not able to be devalued through inflation. This differs from fiat currency, for which governments can print more money in order to stimulate an economy. This eventually leads to an increase in money supply in an economy and an increase in the price level due to a decrease in the value of money, causing currency devaluation. The negative comes with the fact that an increase in the price level and devaluation of money increases the opportunity cost of holding money. When the opportunity cost of holding money is high, the demand for money decreases as consumers would rather use their money on goods that will hold their value, therefore stimulating a decrease in aggregate demand for an economy. Finally, the decrease in aggregate demand is said to potentially lead to an increase in speculative demand for money. This could be consumers buying and storing cryptocurrency with the hope of an increase in price, which of course is highly speculative, but at this point in time there are no clear indications or evidence of this happening.