When markets start getting rid of excesses—excess valuations, excess liquidity, excess leverage, and so on…the most popular investments tend to suffer the most.
For instance, when markets started correcting at the beginning of 2018, mid and small caps witnessed massive corrections.
In the previous multi-year bull market of 2003-08, infrastructure companies had witnessed a parabolic rise during the market upswings but eventually they got battered, trapping the late entrants.
At present, cryptocurrencies such as Bitcoin and Ethereum are hot investments. What will happen to them if the majority of governments decided to clamp down?
The Indian mutual fund industry has 11.44 crore accounts/folios of which 9.34 crore folios are under equity, hybrid and solution-oriented schemes. The industry took more than three decades to attain the milestone of 10 crore (100 million) accounts.
But guess what, over 10 crore Indians (nearly 7% of India’s population) now hold cryptocurrencies, such as Bitcoin. The popularity of cryptocurrencies in India skyrocketed over the last few years.
Simply put, cryptocurrencies are digital currencies free of any central bank’s control. They can be used to buy goods and services though. But that’s not the only use case.
Food for thought…
The collective market cap of 14,705 cryptocurrencies that exist today is USD 2.54 trillion and the GDP of the US alone is USD 21 trillion. Do you think any single cryptocurrency can replace any of the major currencies of the world anytime soon?
But excitement and liquidity can defy all logic!
Incessant money printing in the west was the primary reason that brought cryptocurrencies such as Bitcoin and Ethereum in the limelight. The Federal Reserve’s balance sheet expanded from USD ~4.2 trillion in February 2020 to ~8.5 trillion in October 2021 on account of the pandemic.
However, the most crucial factor that made them popular is the returns some cryptocurrencies generated over the last one decade.
For instance, the price of Bitcoin rose from USD 2.97 in November 2011 to over USD 57,000 in November 2021. Such unprecedented price moves are luring more investors to the asset class of cryptocurrencies which is highly speculative in nature.
Like gold, even cryptocurrencies don’t generate any cash flows. Like gold, they don’t earn you interest. Again, like gold, their value is always relative to that of other asset classes, including the US Dollar.
Bitcoin is the new gold, many proponents of Bitcoin claim. But you must take these claims with a pitch of salt. Not just Bitcoin but all cryptocurrencies put together are too far from being able to replace gold as a reserve asset.
Gold has a universal appeal.
The biggest difference is gold has track record of thousands of years and it’s recognized as a reserve asset by governments and central banks across the globe.
And it protects the purchasing power of consumers. In other words, gold shields you from the ill effects of inflation.
Despite this, gold has become less popular in relative terms vis-à-vis some leading cryptocurrencies such as Bitcoin.
According to a study conducted by World Gold Council, stagflation has been the most frequent scenario in the US over the last 50 years.
You would be surprised to know 68 of the last 201 quarters saw stagflation which at max lasted for 8 consecutive quarters.
For the purpose of analysis, stagflation is defined as any quarter where growth decelerated and inflation accelerated on a Y-o-Y (Year-on-Year) basis.
Until recently, the consensus was the inflationary trend is transitory and thus many central banks decided to look through it. However, with passing time, experts and investors have started worrying about the persistence of inflationary pressure.
Historically, gold as an asset class has done well during the phases of negative/lower real interest rates and stagflation scenarios.
You see, the foundation of cryptocurrencies is based on distrust of central banks and governments. Staunch believers of cryptos feel that central banks are slowly losing control over the monetary situation. To support growth they aren’t left with many options and might have to hold interest rates lower despite sharply rising inflation.
But can cryptocurrencies resolve these issues?
Well, if you are an Indian investor betting on cryptocurrencies, you must ensure that you understand the risks associated with them. Any synchronized action by multiple governments across the world to regulate cryptos might be a huge sentiment dampener.
Against that, gold is free from any such potential action.
You may also like to read: Is value the new mantra for portfolio growth?
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