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Accepting risk: Bitcoin and Covid-19

Updated: Apr 24, 2021

Humans deal with new risks in a very similar way. Both Covid-19 and Bitcoin are new events in our lives and it is fascinating how similarly we reacted to them. Initially we were afraid of these new "things" but then we just got used to them, accepted them and here we are investing on Robinhood and socializing, even thought the risk hasn't changed.

 

In 2020 we witnessed two phenomenal events. On one hand humanity lived through its first global pandemic in the age of internet, and also we saw how the price of Bitcoin skyrocketed to the skies. On first look those two events doesn’t seem to have much in common, and this is true except that both are great example how people handle risk. In both cases we can observe how people are accepting the risk and underestimated even though objectively it is the same (if not higher).


What is risk?


In our mind risk is the probability of a given outcome to happen. In reality we are concerned with bad outcomes like getting infected with Covid-19 or losing money on the stock market. Calculating risk is also extremely easy it is just a probability (shown as %) and it should be very easily understandable. People are generally risk-averse meaning they don’t like risk, therefore logic suggest that people will try to avoid high levels of risk.

It is really amazing how great research that is made 3 decades ago is working now. The most basic theory of risk management says that people go through several stages of handling risk:

  • Avoid (fear) – when something risky occurs like Covid 19 in our lives or Bitcoin phenomenon on the financial markets, first we don’t like it and try to avoid it. This first stage plays on our fears of the unknown;

  • Accept – after we gather more and more information we start to understand this event and begin living with it, because we have less fear since it is not so much unknown;

  • Contingency – getting enough information on the risk event allows us to evaluate it and start managing. The first thing that people generally do is to make some preparation if this event occurs;

  • Management (reduce/transfer) – real risk management occurs when we use tools to reduce or transfer the unnecessary risk.

Bitcoin and Covid-19 share similar treat – both were new and risky events in our lives and we didn’t have any information in the beginning. It is really fascinating how similarly people have reacted to both events. Now lets discuss these 4 stages of risk reaction in the context of both events. The idea is if we can get some insight into the future of Bitcoin based on our response Covid-19.


What Covid-19 has shown?


Humanity faced with this terrible disease in the beginning of 2020 when Covid-19 started spreading around the globe. In these initial stages the only thing we knew it is really infections and more importantly it had death rate around 3% making it more deadly than the usual viruses that we faces. So far the progression of this pandemic is:

Chart 1: Covid-19 Pandemic Progression

Source: WorldMeter


This was new to people and societies started to panic and make every precaution. We saw severe restrictive measures to contain the spread of the diseases. Note that number of active cases were around 50k a day. After that things suddenly calmed down in the summer where we saw loosening of restrictions and more social activities (vacations , travels and more). BUT in the meantime the number of daily new cases has been growing. It is really fascinating how quickly we adapted to risk: in the spring we were locked in our houses, but in the late summer and autumn we were on the beaches even though the number of daily cases was 10x bigger. Last stage thus far is the Contingency, when we developed the vaccine we choose to take it just as a precaution even though we are already used to the risk.

It seems a scandal and stupid but this is not something new. Human’s ability to adapt to new events has been well documented in science. This is just the way we react to new risks. Following the scientific logic next stage is our real management of the pandemic where we manage restrictions, vaccine and so on. BUT lets get back to the investments, regarding the future developing of pandemic we can just hope for the best and wish luck to everyone.


What about the Bitcoin?


The similarity between Covid-19 and Bitcoin is uncanny – both are new and unknown things in our lives and both are risky events. Covid-19 is strictly bad risk, but in the case of Bitcoin it is risk but can offer reward. The background of Bitcoin shows that this new cryptocurrency with shady reputation hit the markets and people had the chance to invest in it. So how investors handled this new risk:


Chart 2: Bitcoin price and risk history

Source: Investing


Fascinating how the same conclusions from Covid 19 can be taken to Bitcoin. In the beginning it was a investment that can bring a lot of return but with high levels of risk, this is why people were afraid. It is unknown and we can’t figure out how it will go. This is why for first two years it didn’t attract big time money. Then just in the pandemic we had similarly “quiet” period even though the risk was still high. In this period investors got used to Bitcoin existing and started considering it as viable investment. Here we are in 2021 where everyone accepted the risk in Bitcoin and it starting to attract more and more investors with big money using Coinbase.


What’s next for Bitcoin?


Based on how people are reacting to the Covid-19 we can discuss what is going to happen to Bitcoin. Luckily in the case of Bitcoin we can distinguish only first two stages of person’s reaction to risk, while regarding the pandemic we can see start of phase 4: management. So keeping the model we can say that in the near future Bitcoin investors will go through:

  • Contingency phase – okay we have high returns, we bought in so now it is time to start taking precaution. Most people’s investment in Bitcoin now needs some form of hedging to protect risk. So what options we have? What assets are negatively correlated and have the same prowess in volatility to hedge Bitcoin? From performance standpoint is it enough total return, what about alpha? So now in Bitcoin investing people must involve investment researchers to make a deep quantitative analysis and get into the details, because now we have real money behind it.


  • Management phase – once we have more investment research behind Bitcoin investors will start proper investment management. Moves like when to enter or leave, how to hedge and so on. Once this happens then Bitcoin should reduce its volatility and become normal financial investment opportunity.


It is really fascinating how people react to these new events. It is really exciting and we will keep investigating this new phenomenon.


So did you accept the risk and bough on Coinbase?



#Staysafe

#Bitcoin

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