Coronavirus, Bitcoin and the White and Black Swans

This article is not about the effects on the world health of the rapidly spreading COVID-19, better known as coronavirus. Rather, it is about the effects that a pandemic could have on the most widespread and “oldest” cryptocurrency on the planet: Bitcoin.

Let’s start by clarifying that attempts to justify the growth or decrease in value of Bitcoin as a consequence of events of global importance have typically proved completely useless and without valid economic foundations.

Bitcoin’s volatility is determined by many factors and predicting its performance is more complex than predicting Juventus’ final result in a Champions League match.

Crystal ball, gambling or whatever. The reality is that Bitcoin’s growth in value is generally uncorrelated to world events such as the political crisis between Iran and the United States or the spread of COVID-19.

Major value shifts are often correlated to the coin’s constant technological evolution and “halvings”, that process of reducing the rewards provided to miners for mining blocks on the Bitcoin blockchain.

Halvings are the basis of the economic models of the cryptocurrency and guarantee that the coins will be issued at a predictable continuously decreasing rate. This controlled rate of monetary inflation is one of the main differences between cryptocurrencies and traditional fiat currencies, which essentially have an infinite supply.

Each halving, therefore, represents a particularly important phase for Bitcoin and its scarcity. Today, there are about 18.2 million bitcoins in circulation. The total of bitcoins that will ever be produced is 21 million.

It will, therefore, become increasingly difficult to “create” new bitcoins through cryptographic hash algorithms, the complex mining processes created by Satoshi Nakamoto in 2008. Once the maximum quota of 21 million has been reached – in May 2140 according to the latest estimates – Bitcoins can only be purchased from those who already own them. There will be no further “issuance” of new ones. As inflation goes to zero miners will obtain an income only from transaction fees which will provide an incentive to keep mining to make transactions irreversible.

The 32 halvings (two of which already occurred in November 2012 and July 2016) are much more likely to act as the basis of a growth in the value of bitcoin than a pandemic like the Coronavirus.

What emerges, in light of the recent spread of the virus initially found in the province of Wuhan and soon spread to the rest of the world is that the narrative that Bitcoin is a safe haven asset to refer to in times of planetary instability proves to be unfounded.

Of course, the political crisis between the United States and Iran following the murder of Qassem Soleimani coincided with a sharp increase in Bitcoin from USD 7,000 to USD 8,500 in a week. Just as in mid-2019, Bitcoin had risen 100% following the Trump administration’s announcement of an increase in tariffs on imports from China. But both of these political crises have not had an impact on confidence in the health of the financial markets as is happening in the case of coronavirus globally.

By contrast, Bitcoin faithfully followed the loss in value of the Dow Jones (down 900 points on February 25 only) and the Standard & Poors 500 (which closed the same day with a 3% loss). In fact, between 19 and 26 February Bitcoin collapsed like all other stocks from 10,000 USD to 9,150 USD.

Following from the comments recently by billionaire Warren Buffet and renowned economist World Nouriel Rubini on the many problems with Bitcoin, many insiders are currently asking themselves, “is Bitcoin the black swan or just one of the many white swans?”

The “black swan theory“, proposed by the Lebanese epistemologist and trader Nassim Nicholas Taleb, refers to unexpected events of great magnitude and consequences, and their dominant role in history. These events, considered extremely divergent from the norm, collectively play a much more important role than the mass of ordinary events.

Taleb believes that the black swan theory has specific empirical and statistical properties which he calls “the fourth quadrant”. The Taleb problem is related to the cognitive limitations of the decision-making process. These limitations are two: philosophical (mathematical) and empirical (human prejudices). The philosophical problem is related to the scarcity of knowledge available at the time of the analysis of rare events as these do not appear in the statistical samples of the past. In the fourth quadrant, knowledge is uncertain and the consequences are enormous.

Now, unlike the black swan, white swans are predictable and intuitive. In a sense reassuring. It is these white swans that large investors and economists such as Buffet and Rubini tend to focus on and trust.

Perhaps, after all, in spite of the great Bitcoin supporters, the cryptocurrency born from a mysterious character who has since disappeared into thin air, has become over time, like many other assets, a normal white swan. This may partly be a consequence of the creeping assimilation of crypto to the world of traditional finance (bitcoin-based futures, large companies like JP Morgan evaluating Bitcoin investment options, etc.).

The world has somehow already changed Bitcoin from what it once was. Traditional finance is now so engaged with this currency that governments are now regulating the phenomenon, recognizing its value or even creating their very own “state cryptocurrencies”.

At the same time tech giants such as Ten Cent and Facebook have begun to build parallel coins to be spent globally among subscribers to their web platforms.

Bitcoin has created new professional skills: developers, traders, lawyers, tax consultants, notaries have invested part of their time to understand the phenomenon, study it and try to provide useful contributions up to the legislative level to support this financial revolution.

But it also jeopardized the savings of many inexperienced consumers who, attracted by the growth in the value of the cryptocurrency or, worse, simply felt into the trap of many scammers, have lost most, if not all, of their savings.

Bitcoin is still a mystery today. We do not know if it will be the common currency of the future or if, as claimed by many of its detractors, it will only be a tool to cheat the masses or launder dirty money. Of course, following the advice of the wise Lao Tzu in the case of the definition of Tao, we can say what it is not:

Bitcoin is not yet a legal tender in any jurisdiction, even if it can be largely used as a payment method. Its legal status varies substantially from state to state and is still undefined or changing in many of them.

It still does not behave as a safe haven asset like gold.

It is not yet a viable payment instrument since it is not yet universally adopted as the Dollar, the Euro or the Yuan.

Yet it is there. Probably to stay and not to leave. Probably to accompany the other traditional financial assets and FIAT currencies thanks also to increasingly stringent sector regulations and an ever growing interest from traditional financial entities.

Certainly this 2020 (a leap year for the superstitious), will be the first real long-term test for Bitcoin as the worldwide “fear” unleashed (rightly or wrongly) by the coronavirus has inaugurated the most interesting stress test for the original cryptocurrency since its conception.

Avv. Massimo Simbula (Legal Advisor, AmaZix Ltd)

Paolo Anziano (Founding Partner, AmaZix Ltd)

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