Is bitcoin a safe asset? David Andolfatto, vice president of the Federal Reserve Bank of St. Louis, acknowledges in his blog, “MacroMania,” that bitcoin can be volatile over a short time span. But when people speak about safe assets, it’s not the same as providing a stable rate of return.
Andolfatto, in considering what makes an asset truly safe, thinks bitcoin does have some important safety properties to consider, either for personal investing or policymaking.
A safe asset is one people go to during uncertain economic times. In normal times, a safe asset is one that people hold despite a low return rate, possibly due to its use as a hedge, or liquidity characteristics.
Many view U.S. Treasuries (UST) and U.S. dollars as safe since they are fairly risk-free in their nominal return rate. A USD gives a zero nominal interest rate. A UST also gives a zero nominal interest rate along with full principal payment upon maturity.
Andolfatto points out that there’s more to thinking about a security’s risk. Investors don’t care how many paper dollars they are promised in the future. They care about the purchasing power those dollars will bring. Inflation can cut purchasing power or build it depending on inflation.
The UST bill’s market price generally fluctuates from the issue date to maturity. Buy a bill promising $100 a year from now for $99 and you make close to 1% holding it till maturity. But if interest rates rise before then, you’re likely to suffer a loss if you have to sell the bill to raise cash.
The return on a safe asset can appear stable over long time periods, but in the interim, something could happen. Interest rates can rise and a sudden bond sell-off can occur. There are various events that can cause this to happen. Foreign banks can liquidate their foreign reserves of USTs for economic or political reasons. Inflation expectations can cut the expected real return rate for nominal bonds, causing a sell-off. A productivity gain can boost expected return on private capital, causing substitution of bonds.
In 1974, investors fled USDs and USTs and flocked to real estate and gold. In 2008, USDs and USTs were highly sought-after as investors fled real estate.
These situations indicate that monetary policy regime changes are important regarding whether a fiat currency is seen as safe. When President Nixon abandoned the gold standard against the recommendation of the Federal Reserve Chairman in 1971, monetary policy appeared to lose its nominal anchor. When oil prices rose and productivity fell in the early 1970s, investors ditched cash.
According to Gary Gorton, a safe asset has a lot to do with information symmetry:
“A ‘safe asset’ is an asset that can be used to transact without fear of adverse selection; that is, there are no concerns that the counterparty privately knows more about the value of the asset.” (Safe Assets, Working Paper, March 2016).
A safe asset has attributes that traders mutually agree on, quickly and at low cost. Such objects often become monetary instruments or exchange media. The purpose of coins was to make objects easily recognizable with little effort.
Cash and gold are simple objects. There is no need to spend time examining the reliability of the dividend paid by a barren asset; everyone knows there is no dividend. Such information symmetry is in high demand during financial uncertainty.
Bitcoin has the properties desired in a safe asset. It could be the next big safe asset.
Bitcoin is also a simple asset in that it is a pure fiat object. The monetary object (bitcoin) has no legal claim against anything of legal value. It is merely a record-keeping technology that pays no interest. Possession corresponds to ownership unless there are counterparties involved.
There are aspects of bitcoin that are not simple. There is technology behind it that many people don’t understand. But most people don’t fully understand how their car engine works, yet they do have some understanding of how it works. They also know that the expertise needed to help them with it if necessary is readily available.
Bitcoin also has a very simple monetary policy. The policy is to keep the money supply fixed. While the supply can be changed by consent, this is not likely to happen. If it does happen, it will only happen if it serves the bitcoin community in some way.
There is a block size debate going on today with bitcoin. It is possible that there will be a need to finance the book-keeping cost of bitcoin. Eventually, it may only make sense to hold bitcoin for large value transactions.
But even if this happens, bitcoin will remain a safe asset. (Smaller investors could invest in bitcoin ETFs, even though this would introduce counterparty risk.)
Even if bitcoin is not an ideal monetary instrument, it can still be a safe asset or longer-term store of value. When market penetration completes, bitcoin’s behavior will likely mimic the return behavior of any other safe asset. Such assets usually earn a low expected return.
Investors expect to earn high returns in the event of a crisis. But if you buy near the top, you expect to realize exceptionally high losses when the crisis passes. It’s a great investment if you can predict when a crisis will begin and end.
There are many issues relating to safe assets. For one, it is not clear that safe assets are socially desirable. The existence of a safe asset can stimulate coordination failure. Second, policymakers should know the class of safe assets can change over time. Should a policy be based on the existing safe assets? Third, what it the best way to consider “close-to-sale-asset” substitutes that expand in periods of extended economic tranquility?
Barren assets like gold, cash and bitcoin produce no income. It is tempting to build “safe senior tranches” of private interest-bearing debt to vie with such low-return, barren assets. Should a central bank issue its own interest-generating digital cash to discourage this?
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