Prices of Cryptocurrency are mimicking stocks and bonds like never before, penalising investors who acquired Bitcoin and other digital assets searching for a portfolio diversification strategy.
Between 2020 and 2021, central banks raised the supply of fiat currency that caused a spike in cryptocurrency values and now that the Fed is moving towards Quantitative Tightening (QT) to reign in runway-inflation, crypto and equity markets are bearing the brunt.
Crypto assets like Bitcoin and Ether have minimal link with major market indices before the outbreak. They perceived to help diversify risks and protect against volatility in other asset groups.
However, after the unprecedented central bank crisis responses in early 2020, the scenario altered tremendously.
With easy global financial conditions and increased investor risk-appetite, cryptocurrency prices and US stock values both soared. Arguments such as these have helped convince hedge funds and other professional investors to include Bitcoin and ether in their portfolios.
Retail vs Institutions Activity
Retail traders were dominant around four years ago, when Bitcoin traded below $10k. A third of trading volumes on the Coinbase Exchange was from retail users in 2021, having fallen from 80% in 2018 but that has further taken a hit over the years as institutional interest picked up and Coinbase’s business model adjusted to accommodate institutional needs.
“Increased trading volume share of crypto institutions vs retail has contributed to the high correlation between Bitcoin and equities,” Morgan Stanley said in a research note and added that “the increased involvement of institutions which are sensitive to availability of capital and therefore interest rates, has contributed in part to the high correlation between Bitcoin and equities”.
Big Investors Are Big Believers
Large funds such as Cathie Wood’s ARK Investment Management LLC and companies including Elon Musk’s Tesla Inc. and Michael Saylor’s MicroStrategy Inc. have created positions of Bitcoin large enough to mark their presence which helped ensure the financial markets are aligned with cryptocurrencies.
In effect, the large source of funds is utilized in creating position at both Cryptocurrency and Equities markets simultaneously.
Meanwhile, crypto-related companies such as Coinbase Global Inc. have gone public in recent times which has further helped establish connection between digital currency trading markets with stocks and bonds.
The CITI On Correlation:
Global broking firm Citi mentioned in a research note that “Within equity sectors, Crypto assets appear to exhibit an increasing correlation to cyclical sectors, in particular sectors that are more inflation sensitive such as energy, materials and industrials.”
CITI Research also noted that market volatility and inflation expectations share a similar negative relationship to financial market volatility and noted “we find a weak statistical association between crypto returns and inflation expectations. Both these attributes have only become prevalent recently and had been distinctively weaker historically,”
To sum-up, the high degree of correlation between Cryptocurrencies and Financial Markets is thoroughly established by relative price movements that follow similar key factors. The strong connection between Bitcoin and stocks comes amidst growing macro-economic concerns, geopolitical uncertainty and a tightening monetary policy.
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Manoj Dharra
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