Published : 5 years ago, on 11/09/2019

David Mercer, CEO of LMAX Exchange Group, which operates LMAX Digital, comments on the effects of the current trade war, currency volatility and how cryptocurrency could emerge as a ‘safe-haven’ currency.

As trade wars continue to gain momentum, creating more volatility in capital and currency markets, many are looking for alternative options to ensure they can maintain the value of their investments. During these times, people tend to go to the so-called ‘safe-havens’.

In the past, ‘safe-haven’ status has been attributed to gold, considered as an archaic standard with no intrinsic value by many.  Although still at a nascent stage, people and institutions are starting to view cryptocurrencies as a store of value.

One of the benefits of cryptocurrency is that it has a limited supply, which protects the intrinsic value of the currency. This characteristic means that cryptocurrency has the potential to emerge as a new safe-haven asset. However, legislative, regulatory and liquidity issues need to be addressed before crypto achieves widespread adoption among both, retail and institutional markets.

Strategic trade wars

The world’s largest economies, US and China, have locked horns, igniting what is showing signs of escalating into a full-blown trade war. Fear of the broader ramifications of these tensions have been widely reported with real and detrimental impact predicted for global economies and investors.

In order to understand the effects of the current trade war that has stricken the global economy, it is important to first understand why governments impose trade tariffs.

The US is at the forefront of the trade tariff dilemma. The main strategy behind imposing these tariffs is to enact a ‘weak dollar policy’. This is a well-trodden path during times of economic distress and financial crisis, which sees governments attempt to bring down the value of domestic currency to make exports cheaper, while imposing tariffs on imports to rebalance the economy.

Dating back to the 2008 crisis, the US Federal Reserve has consistently intervened, artificially boosting the economy, with no exit plan. The idea was to further balance out the US deficit by creating a barrier to foreign imports. The US has a vast trade deficit as it is a massive consumer-driven economy and sources many products desired by consumers from abroad.

In theory, the introduction of trade tariffs, coupled with dovish monetary policies, such as lower interest rates, should temporarily boost the economy. If the currency weakens, the US economy can strengthen.

The race for the weakest currency causes detrimental effects

The problem with this strategy is that what was meant to be a temporary boost while the economy recovered, is still ongoing. The Fed has recklessly incentivised a one-way trade into the stock market for over a decade.

What is left is an inflated stock market falsely promising hope for citizens. Average disposable income is increasing due to longer working hours and rising employment levels, whilst real wages themselves have not gone up and housing prices continue to increase. This is causing consumers to lose trust in the central government intervention policies.

Investors have come to expect record stock market highs in the US, leaving them over-exposed when news of a negative downside risk shock occurs. This increases the potential for radical market movements.

When stabilising the economy, the US has driven many global powers into a race to weaken their respective currencies – no one wants to have currency appreciation.  The European Central Bank is lashing out at the US President for threatening sanctions because they want to avoid an appreciation of the Euro; the Bank of Japan and the Swiss National Bank are following suit to avoid an appreciation of the Japanese Yen and the Swiss Franc.

The US set the wheels in motion and now all the competitive central banks are pumping money into their respective economies, in the race not to be left with the most expensive currency. Now the trade war looks to be escalating, deflationary pressures are resulting in unprecedented currency volatility and risk.

The search for a ‘safe-haven’

With all this uncertainty in the market, more common in emerging economies but less so in developed markets, people are feeling the pressure and becoming worried about the lack of protection for the value of their savings. Investors are wary that the consistent equity market highs will plateau, while consumers are conscious that this economic prosperity isn’t trickling down into their pockets.

The search for a ‘safe-haven’ currency has begun. Historically, gold was always viewed as the stable currency because there is only a limited amount of it in the world and central governments cannot simply print new gold.

Cryptocurrency has been built on the same principle and may provide a more legitimate option. As gold, only a limited number of coins are available for trade. However, by using blockchain technology cryptocurrency adds another layer of protection that allows for a detailed trail of all trading history. So why aren’t investors and consumers rushing to digital currencies in times like this?

In order to understand this, it’s important to take a step out of the West and into the East, where consumers have been crippled by continuous volatility and have adopted cryptocurrency as a ‘safe-haven’ for their hard-earned money for years.

Dating back to when cryptocurrency first entered the market in 2009, many migrant workers were reliant on sending the profits of their labour back to family members. For example, these workers would make the equivalent of £3 an hour and deposit the money into their bank.

At the end of the week, when they went to send the money home to their families, they would discover that their money was worth next to nothing as the exchange rate had dipped massively. By this point they stopped trusting governments to tell them how much their money was worth and sought different options. Cryptocurrency became the obvious means to pass on their savings to family members.

With a limited amount of coins protecting the value of their money, these migrant workers could take comfort in getting paid in cryptocurrency and knowing that the government could not strip them of its worth.

Fast forward to modern day and cryptocurrency is now accepted widely in most Asian countries. So why is the use of digital currencies in the West not widely spread? And why would anyone choose to get paid in a currency that is ultimately controlled by a governing body and can change at any instance?

What needs to change?

Western societies are now becoming accustomed to currency volatility and are finding themselves in a similar predicament to the migrant workers touched on earlier. The idea that there is a currency that is uncorrelated to government intervention seems comforting, yet the mentality of western cultures still deems this as unsafe due to lack of regulation.

One of the major reasons why the transition into digital currencies hasn’t happened quite as quickly in the West is the number of barriers blocking crypto from being readily accepted.

In order to overcome these barriers, cryptocurrency has to become crystallised as an asset class and institutions will need to begin investing a portion of their portfolio in cryptocurrency as well as actively trading it on crypto exchanges.

For this process to take place, an established internationally trusted marketplace needs to be in place to enable institutional cryptocurrency trading. This hinges on the provision of credit by the banking system, which is at odds with the inspiration behind the Satoshi Nakamoto whitepaper, the paper that was the precursor to Bitcoin. Credit plays an important role in providing traditional fund managers or hedge funds with the funds to execute their trading strategies.

At the moment, credit – the oil that greases the wheels of institutional finance -is grossly absent in cryptocurrencies.

The next step is the implementation of proper regulation, to both, protect the retail consumers and to get institutions comfortable to operate in this marketplace. Once consumers and their coins are protected, institutional players can self-regulate the market. It will be essential for institutions to trade digital currency according to international norms.

Another barrier is the lack of liquidity. But this problem is easier to solve as institutions can resolve this issue by bringing in capital and helping create a more fluid market.

Lastly, the lack of infrastructure needed for sourcing cryptocurrency is another barrier. As they stand, digital currencies are massively expensive to produce due to their energy consumption and because there is no way to efficiently mine units. As more players try to enter the industry, the funding will come, enabling proper, more efficient infrastructure to be built.

The time is now

The world is frustrated with government and central bank intervention and is thirsty for another way in which they can hold and maintain the value of their assets. People need a way to protect the value of their money, regardless of the level of central bank manipulation and intervention.

Cryptocurrency has the framework and ideology to emerge as a ‘safe-haven’ currency in such volatile times, but there are large roadblocks in the way. If some of these barriers can be resolved to encourage institutional investment in digital assets, the world benefit from an alternative asset in which to park their money, or a ‘safe-haven’.

By David Mercer, CEO of LMAX Exchange Group, which operates multiple institutional exchanges for FX and crypto currency trading. LMAX Digital is the Group’s cryptocurrency exchange that focuses on institutional investors only.