A Tsunami is never just a wave…

How Coronavirus and the global economy may impact Bitcoin in 2020

A shortened version of this ran on GeekWire today.

The team at Strix Leviathan was recently asked to provide our perspective on what’s been happening and particularly how it intersects with the recent events in traditional markets. To be clear, Strix Leviathan operates a quantitative digital asset fund taking systematic long and short positions in large-cap digital currencies including Bitcoin and Ethereum, so our perspective on the global economy doesn’t have a major impact on the day-to-day operation of our business. We do, however, live in a world of news and numbers and the narrative that’s being woven by current news and numbers is important to share. Headquartered in Seattle, WA, we have been feeling the effects of the first viral hotspot in the United States for the last few weeks.

In this post, we will walk you through our perspective on what’s happened over the last few months regarding Coronavirus and the global economic landscape. We’ll then walk forward on how the events of the coming weeks may unfold. Lastly, we’ll circle back to crypto and cover how the global economy and the upcoming Bitcoin halving are playing into the current price action.

We’ll start at the beginning…

In late January, the first case of Coronavirus crept inside the borders of the United States when a traveler from Wuhan, China, returned home to the Seattle metropolitan area. That initial case spiraled into full blown community spread which is being documented by the amazing work of Trevor Bedford and the team at the Seattle Flu Study. We are now seeing similar issues rising across the entire United States. Coronavirus is just one part of this story, and one that we’ll revisit shortly.

Over the last week, we’ve witnessed the S&P 500 experience its worst day since the 2008 financial crisis while the VIX index that measures market volatility has spiked to its highest measure since 2008.  Last Sunday, WTI and Brent Crude fell over 24% on the back of a failed OPEC deal. On top of all of that, the markets saw a mass exodus to traditional “safe havens”—US Treasuries. This movement pushed US Treasury yields to historic lows

We are diverging so far from what has grown to be considered “normal” over the last 12 years that many people simply forgot that shocks to the system are a consistent and repetitive phenomena  in markets. Up and to the right has never been normal or guaranteed, the past 40 years have bolstered a false belief that this will continue indefinitely.

Coronavirus has impacted the obvious industries: airlines, tourism (cruise lines in particular), hospitality, events, and restaurants. These industries feel the immediate pain of global quarantines and shutdowns. We are seeing it today—flights are empty, the cruise industry is being  shunned, and restaurants are closing down.

More importantly though, coronavirus is just getting started in the United States. People in the United States are slowly waking up to the fact that the rhetoric that this was “just a flu” was nonsense. The mortality rate currently calculated from the Johns Hopkins Coronavirus tracker sits at ~3.6%, which is orders of magnitude greater than 0.09% for traditional influenza. However, the mortality rate is likely overstated due to the fact that countries including the US are not broadly testing prospective carriers, so the sample size of the total infected is not representative of actual population infection.

A Brief Tour of How Bad It Can Get

The bigger and more concerning issue is the R0 which is the measure of how contagious an infectious disease is. Coronavirus has an estimated R0 of 2.28 meaning each infected individual infects between 2 and 3 more people – i.e. the virus keeps spreading unabated. This can be stopped two ways: a vaccine or containment. 

Let’s look first at vaccines. While vaccines are actively being developed and there is encouraging news on that front, they are unlikely to become available for the general population for a year or more due to clinical trials and regulatory processes. That leaves containment, a strategy that has so far failed in the United States. Once the infection has reached community transmission, containment requires sweeping social measures as seen with the lockdown of Hubei province in China (population 58.5M) and the entire country of Italy.

Containment is critical because this particular virus is causing a significantly higher set of complications in those it infects compared to influenza. In Wuhan, 14% of the measured cases were diagnosed as severe. These are cases that require intensive care including ventilators, for an extended period of time. Recovery can last up to 8 weeks and can leave individuals with long lasting medical issues. At 14%, if this virus becomes endemic and spreads within the population of the United States, we’re going to risk the collapse of the health care system’s ability to care for patients.

This failure of the healthcare system is the primary reason we are seeing more calls for mitigation — to “flatten the curve”. If containment has failed, the next best thing that can be done is to stem the tide of concurrent infection. This is the goal with the cancellation of events, and school and with self-isolation – to ensure we do not overwhelm the hospital system. 

In technical terms, hospitals globally are already experiencing a DDOS – distributed denial of service. It happened in China and is now happening in Italy already. Not only is hospital capacity a problem, but to date, medical staff are struggling with their own exposure with asymptomatic caregivers actively caring for patients. As infection rates increase, patients will outnumber doctors and nurses able to care for them.

The United States Must Do More, Immediately

The United States must begin to take this virus seriously and enact measures to stop the community transmission propagating across the country. Broadly speaking, our government is downplaying the risks we face and the country continues to make irrational and dangerous decisions. Failure to act at either the private citizen, regional or federal level is simply watching the tide recede before the arrival of the tsunami. Citizens must practice self-isolation. Events must be cancelled. We must flatten the curve.

What’s next for the global economy?

Manufacturing in China has been at a standstill for almost a quarter. While this has been beneficial for air pollution, this also means the global supply chain has been shuttered — something which is likely to have profound consequences on a wide swath of businesses. In short, Q1 earnings—which begin to be released in a few weeks—are likely to miss. Just how much they miss is anyone’s guess but we’re seeing this already as companies amend their earnings estimates. 

Global governments will try to solve this through economic stimulus. Unfortunately, governments never took their foot off the gas from the stimulus used to resolve the 2008 economic crisis and the gas tank is running dry. The government is out of ammunition and whatever they come up with is likely to add significantly to the national debt. 

An important closing question is to think through how Coronavirus eventually burns itself out. Without a vaccine, and with an R0 greater than 1, this virus is likely to continue to even the most isolated areas and populations. Additionally, the rate of relapse and recurrence for this virus is unknown at this point. Speculation from China is that humans may not develop immunity and could succumb repeatedly to this illness:

“For those patients who have been cured, there is a likelihood of a relapse,” Zhan Qingyuan, director of pneumonia prevention and treatment at the China-Japan Friendship Hospital said in a briefing on January 31. “The antibody will be generated; however, in certain individuals, the antibody cannot last that long. (source)

While China’s containment seems to be successful and the broader China economy appears to be restarting, it is entirely possible the country will see a reinfection in the coming months. The world needs a vaccine and we must hope it finds one sooner rather than later.

So, what about crypto currency?

All of this brings us around to our area of expertise: cryptocurrency. How will all the chaos in the world impact the price of Bitcoin? No one knows. And anyone that claims differently is selling you a bag of goods. This asset class is experimental and thus entirely speculative, and despite being labeled as a safe haven asset immune from the whims of the global economy, Bitcoin did not exist during the 2008 economic crisis. Ironically, it was formed out of the ashes of that spectacle and has existed solely in a risk-on global macro climate. Given that Bitcoin has never existed during any form of global financial turmoil so there are zero data points to extrapolate from.

Over the last few weeks, Bitcoin’s price action has followed closely in line with regular markets, surprising many and damaging the notion of Bitcoin’s lack of correlation. When we started working on this piece, the price of Bitcoin was hovering around $8,000 and in the following 24 hours has fallen more than 25% to $6,000. Global markets are scared and behaving as if investors are running for the exits on almost everything.

Crypto needs a significant amount of new capital to enter the space to break out of the global downtrend that began at the end of 2017. A major question we keep asking is where does that capital come from?

Retail investors entered en-masse during the great crypto bubble of 2017 with huge inflows of capital. As that bubble popped, many of those retail investors lost significant sums of capital and have grown skeptical and impatient with the asset class. Those that remained experienced repeated false excitement of another 2017-style bull market only to be met with incredible selling. This has become maddening for many. 

We expect that many retail investors are so underwater that “hodling” will persist, but we have limited expectations that they add substantial sums to their positions, particularly as other investments fall off a cliff. Others will give up entirely, the pain of astronomical drawdowns too much to bear.

At $6,000, Bitcoin is down ~16% year to date and ~68% from its December 17th, 2017 all-time high, underperforming the S&P over that same period of time by ~100%.

The entry of large-scale institutional capital has long been pointed as the saving force since those December 2017 highs. That capital is always believed by many to be just 3-6 months away. We believe we are likely much further away from major institutional inflows given the current economic landscape combined with the current regulatory environment, and a number of other issues. Institutional allocators have other fires and little reason to embark on further diligence of a small, speculative, experimental asset class at the moment. Particularly one that does not have a sufficient track record or established relationship within the broader system of financial markets. 

One argument that you hear frequently is that the looming Bitcoin halving will cause a dramatic rise in the value of Bitcoin. This has been widely popularized by the “Stock to Flow (S2F) model” – a model we don’t think particularly highly of. A popular narrative within the cryptocurrency space is as follows:

“The halving of mining rewards has the effect of reducing sell pressure from miners which in turn creates an imbalance in supply and demand that then facilitates a dramatic escalation of price.”

However, after completing an analysis of prior halvings, we found that there is limited impact of a halving event on pricing action. It appears more likely that the return behavior before, during, and after a halving coincided more with increasing levels of speculation than with an underlying shift in sell side pressure.

In our view, it is not possible to make statistically meaningful claims regarding the impact of the halving given that there only exist two prior data points. The last two halvings occurred in 2012 and 2016 with markets (both crypto and traditional) that were dramatically different in nature. Bitcoin has moved from a world of hobbyist miners into the world of industrial-scale miners that utilize all of the financial tools at their disposal (i.e. options, futures, lending). Further, neither of the previous two halvings occurred while the global economy stood on the precipice of a recession.

That said, we do believe the halving will have some measurable impact on the broader cryptocurrency space. Cutting miner income in half creates incredible economic pressures on the mining industry. This industry has thrived with access to cheap credit and the benefit of a significant profit premium over the last few years—two beneficial conditions that are about to come to an end. We believe selling pressure could be on the horizon as miners face a confluence of factors, including damage to balance sheets, limited availability of financing and a reduction of mining rewards. 

With few people buying, and with miners selling, there are enormous headwinds facing the Bitcoin markets. 

In closing…

Where some see doom and gloom, others see opportunity. 

“It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.” – Theodore Roosevelt

Despite those major headwinds, there will be a recovery, of that we are certain. It is possible the speed of that recovery may disappoint many looking for quick riches. However, Bitcoin and the broader digital asset class is here to stay, wild price swings and all. There is power in humility and opportunity within crisis.

Expect the unexpected and please be safe out there. 

– Jesse Proudman