In the early days of Bitcoin and subsequent cryptocurrencies, the pioneers desired to put together functioning virtual currencies separate from the financial system and broader economy. This attracted many people for various reasons, such as no longer depending on the establishment, seeking shelter during times of political or economic chaos, and producing an alternative.
As a result, it had been thought for years that cryptocurrency prices were independent of the stock market. Crypto investors had purported that the movement in Bitcoin or Ethereum had little correlation with the upward or downward trend of the Nasdaq Composite Index or the S&P 500.
This might have been true in the beginning. Today, however, it is quite different.
With more investors turning to Bitcoin, Ethereum, Polkadot, or Cardano, the industry quickly became connected to the stock market. Indeed, there is an increasing interconnectedness between cryptocurrencies and the financial markets, meaning that digital assets have certainly matured into an investment class embraced by Wall Street, institutional investors, and retail traders.
Before the coronavirus pandemic, market observers hardly noticed a crossover pattern between the leading benchmark indexes and premier digital tokens. So, for example, if Bitcoin soared, it did not necessarily mean that the Dow Jones Industrial Average would rally, too – and vice versa.
Researchers are finding that this is no longer the case.
Indeed, during any given trading session, a broad array of factors will influence the direction of equities, be it monetary policy or geopolitical conflicts. It turns out that the same aspects will impact cryptocurrencies, whether it is economic conditions or investor sentiment.
Economists have studied the expanding correlation between conventional assets (stocks, exchange-traded funds, and mutual funds) and crypto alternatives.
The International Monetary Fund (IMF) turned heads in January 2022 when it published a report titled “Cryptic Connections: Spillovers between Crypto and Equity Markets.” The study authors warned that the sentiment in crypto and equities is increasingly connected, which could bolster the “risk of contagion across financial markets.”
“Although initially considered a fringe asset class, their increased adoption across countries—in emerging markets, in particular—amid bouts of extreme price volatility has raised concerns about their potential financial stability implications,” the IMF wrote. “The analysis suggests that crypto and equity markets have become increasingly interconnected across economies over time. Spillovers from price volatility of the oldest and most popular crypto asset, Bitcoin, to the S&P 500 and MSCI emerging markets indices have increased by about 12-16 percentage points since the onset of the COVID-19 pandemic, while those from its returns have increased by about 8-10 percentage points.”
Because of this development, the IMF thinks it is necessary to establish a regulatory framework to eliminate anonymity and adopt global standards.
That said, to support this supposition, here is a chart that compares the price of Bitcoin to the Nasdaq between Jan. 1, 2017, and Jan. 31, 2020:
See, there is very little similarity.
Now, here is a chart that looks at the price of Bitcoin to the Nasdaq between Nov. 1 and Dec. 1, 2022:
The ups and downs between Bitcoin and the Nasdaq are clearly indicated.
But what happened? Well, a few things. The first was that since Wall Street – hedge funds, brokerage firms, and investment houses – had been embracing cryptocurrencies, investors felt more confident parking their money in digital currencies. The second was the expectation that Bitcoin and others would serve as inflation hedges at a time when the consumer price index (CPI), be it in the United States or Canada, was at a multi-decade high. Finally, cutting interest rates to zero facilitated speculation and investors throwing money around at every asset, from stocks to commodities to cryptocurrencies.
Suffice it to say easing global monetary conditions might have cemented a permanent correlation between U.S.-based stocks and crypto.
Even within the cryptocurrency industry, it is evident that two of the largest coins – Bitcoin and Ethereum – trade similarly to each other.
It is safe to say that most investors do their due diligence and study the market before executing a buy or sell trade. Before building positions in Suncor Energy or Apple, traders will comb through earnings reports, assess global conditions, and read market analysts’ recommendations. The same concept must now apply to cryptocurrencies rather than simply searching through message boards and blogs.
Now that global monetary conditions are tightening, the days of easy money are over. The Federal Reserve, for example, has repeatedly confirmed that it will keep raising interest rates heading into 2023 to ensure it has annihilated inflation. Ditto for the Bank of Canada (BoC).
This means that the investment arena will demand patience, balance sheet investing, and ditching poor assets for smart ones. In other words, proceed with caution with any investment, whether you are preparing to construct a stake in Bitcoin or Hydro One.
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