Institutional top of mind | #6

Keep up with the top industry updates as we present bi-weekly market insights that are important to traders in the institutional space.

In this week's edition, Kelvin Lam, CFA, Head of Institutional Research for OKX, sheds light on a pressing concern: the recent geopolitical conflict triggering a "flight to safety" among traders, thereby potentially fueling a rally in Bitcoin.

Top of Mind: exploring the role of Bitcoin as "digital gold" during times of geopolitical tension

TL;DR

Recent geopolitical events in the Middle East have created ripples in the global landscape, drawing attention to the potential impacts on the world economy and financial markets. In this edition of Top of Mind, we delve into how Bitcoin, often dubbed 'digital gold', can play a significant role during uncertain times.

Historical price action of Bitcoin in response to geopolitical events

• The impact of geopolitical events on financial markets is often analyzed in relation to commodities like oil and gold. However, we believe that Bitcoin also faces significant market implications in such circumstances. To understand this, we examined the historical data and the relationship between Bitcoin's price and geopolitical risk. Looking back at data from 2015, we observe that the 7-day moving average of the Geopolitical Risk (GPR) Index has surpassed the 250 level only four times. Each of these instances coincided with major geopolitical events that had the potential to cause economic disasters and affect the financial markets.

Source: OKX, data downloaded from https://www.matteoiacoviello.com/gpr.htm on Oct 18, 2023

• Next, we analyze Bitcoin's performance in the 30 days following these periods of heightened geopolitical risk. As shown in the table below, Bitcoin has consistently recorded positive 30-day returns after the Geopolitical Risk Index exceeded 250. In fact, on the last three occasions since 2015, Bitcoin delivered an impressive average return of 27%. This track record suggests that Bitcoin has the potential to generate favorable returns in the near future.

Source: OKX, data downloaded from https://www.matteoiacoviello.com/gpr.htm on Oct 18 2023

"Flight to quality": accessing exposure to Bitcoin

• There are several possible drivers behind the relationship between Bitcoin and geopolitical crises. Firstly, institutional traders tend to seek exposure to safe-haven assets during times of geopolitical turmoil. Bitcoin, with its scarcity and limited supply, has taken on the role of "digital gold", attracting institutional interest as a store of value. Moreover, the impact of Bitcoin during the current geopolitical crisis could be notably more substantial than in previous periods, primarily due to the increased accessibility of Bitcoin and other digital assets for non-crypto native institutions. These institutions can now gain exposure to Bitcoin through various digital asset custody solutions, enjoying more transparency and control over their funds, while balancing capital efficiency, cost, and security. In addition, a range of financial instruments, including ETFs, futures, and structured products, also offer direct access to Bitcoin within established regulatory frameworks. These instruments provide institutional traders with a seamless pathway to participate in the potential benefits of Bitcoin.

• On the other hand, asset owners inhibited in the affected regions would find the decentralized nature of Bitcoin appealing as a store of value. We witnessed that phenomenon during the conflict in East Europe last year, where digital currencies gained popularity as a reliable medium of exchange and store of value. The current crisis in the Middle East also possesses a distinctive aspect: neighboring countries' heavy involvement in the oil production industry. This situation warrants attention, as any escalation in the region has the potential to exert substantial upward pressure on oil prices. If this happened, it could reignite inflation concerns, which many major economies still grapple with. Bitcoin can serve as an inflation hedge for institutional portfolios during periods of heightened inflationary risks.

• In conclusion, Bitcoin's performance during geopolitical crises is driven by its appeal as a safe-haven asset, increased accessibility for institutional traders, the decentralized nature of Bitcoin as a store of value, and its potential as an inflation hedge. These factors contribute to the relationship between Bitcoin and geopolitical events, as the pursuit of flight to quality remains a prevailing narrative in today's sophisticated financial world. As such, Bitcoin continues to hold a significant position as a potential portfolio diversifier and hedge against geopolitical risks.