Bitcoin has drawn significant attention from investors with its innovative technology and robust returns. The digital currency gained more than 100 percent in 2016, and some believe its price could climb quite a bit more.
However, bitcoin can also act like a safe haven, potentially rivaling gold with its ability to protect investor funds when the value of many other assets is plunging.
This might seem counterintuitive to some, as the digital currency’s high price volatility has prompted some to describe it as a speculative asset.
While these price fluctuations have made bitcoin’s returns a bit harder to predict, the digital currency has frequently enjoyed notable gains during times of macroeconomic turmoil.
Due to this safe-haven status, you can potentially use bitcoin to:
- Profit from broader market crashes
- Protect your principal should other assets fall in value
- Diversify your portfolio and mitigate portfolio risk
Speculate on Market Crashes
While market crashes may not be pleasant for many investors, you can use them to profit by investing in bitcoin. The digital currency’s price has spiked during several events that helped spur significant uncertainty about macroeconomic conditions.
In June 2015, market participants flocked to bitcoin as Greece shut down its banks in an effort to maintain stability in the nation’s economy. A similar situation took place when the U.K. counted the Brexit votes and found that the proposal had enough support for approval.
Practice Makes Perfect
While bitcoin can provide a great way to generate returns when risky assets such as stocks and oil decline, keep in mind that it can be very difficult to determine when macroeconomic turmoil will cause bitcoin prices to surge.
If you want profit by purchasing bitcoin ahead of anticipated market crashes and selling the digital currency when its price spikes, you may want to start off with small amounts of currency. Once you have gotten some practice using this approach, you may decide to work with larger amounts.
Protect Your Principal
Another way you can make use of bitcoin’s safe-haven status is to protect your principal from sharp downturns in the broader markets. Bitcoin is an asset class all its own, as outlined in a whitepaper produced by investment manager ARK Invest and digital currency exchange Coinbase.
Due to its nature as a unique asset, bitcoin’s price movements do not follow or correlate with the price fluctuations of different asset classes. If stock prices, for example, suffer sharp declines, the value of bitcoin might push higher.
Equities frequently lose value when investors respond to bad economic news such as, for example, government figures that fall short of market expectations. However, these developments are exactly the kind of information that prompts investors to flock to safe-haven assets.
If you are going to use bitcoin to protect your principal, keep in mind that one great way to make this work in the long-term is to create a diversified portfolio.
Diversify Your Portfolio
Bitcoin can help your diversify, making your portfolio less susceptible to wild market swings. Ideally, diversification means that a decline in the value of one component coincides with gains in another, ensuring greater stability.
Since bitcoin is in an asset class all its own, its price movements can offset the fluctuations of other securities, potentially helping maintain portfolio stability. (See our guide to diversifying your portfolio using bitcoin.)
Keep in mind that everyone is different, and your portfolio should reflect your investment goals. If you are willing to take on a high degree of risk in hopes of generating strong returns, for example, you might consider a portfolio that consists heavily of equities.
Safe Havens Aplenty
If you are more interested in conserving your principal, there are many safe-haven assets at your disposal. Gold is a perfect example.
While several market observers have compared the innovative digital currency and the precious metal, the two have some very different characteristics. While gold is tangible, it cannot be traded 24 hours a day like bitcoin.
Past that, nobody knows for sure exactly how much gold exists. Bitcoin, on the other hand, is limited to 21 million units under the current rules.
Investors have many other safe-haven assets at their disposal. Government bonds, for example, frequently offer investors high safety of principal. Many consider the debt issued by financially stable governments to be a safe investment. However, this debt may provide very modest yields in low interest-rate environments.
Cash is another safe asset whose value will change very little should other securities crash in value. Holding cash, however, does not provide robust returns. Savings accounts yield little, and holding cash can cause you to lose money as your purchasing power deteriorates.
Summing It Up
By harnessing bitcoin as a safe-haven asset, you can potentially profit from market crashes, protect your principal, and diversify your portfolio. Since the digital currency is in an asset class of its own, it can offer a unique opportunity for diversification.
However, keep in mind that there are many other safe-haven assets available, and most of them have been around longer than bitcoin. As a result, they have far more market history, which can make it easier to predict their price movements going forward.
At any rate, practice makes perfect. Using small amounts of bitcoin when trying new strategies may both help you identify kinks in your plan and also give you more confidence before you make larger investments.
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