For many years following the launch of Bitcoin, the available data left plenty of room for debate over whether or not BTC was correlated to other major asset classes such as stocks or gold. However, over the last few years, Bitcoin has displayed an increasingly convincing correlation to major equity indices such as the S&P 500 or NASDAQ 100. Nevertheless, the flagship crypto asset is also thought to have established its own market cycles over the years based on the periodic halving event, which steadily constrains supply.
Is it likely that Bitcoin is trending towards a stronger correlation with stocks, or is it merely a coincidence that both assets are in a period of bearish activity? This article explores the evolving correlation between Bitcoin and equities.
From Bitcoin’s genesis in 2009 until around 2019, BTC showed virtually no correlation with stocks. To the average observer throughout that period, Bitcoin prices appeared to fluctuate wildly, while stocks were relatively reliable growth assets. Aside from one brief blip in Q4 2018 when stocks briefly slumped at the same time as crypto, the narrative that BTC was uncorrelated was relatively sound.
Within the crypto community, there had been some speculation that BTC could be inversely correlated with the stock markets, meaning it could act as a safe haven in the event of a global economic crisis, fulfilling a hedging role traditionally played by gold. Indeed, this view led to Bitcoin being widely considered “digital gold”. However, following the global financial crisis in 2008-2009, stocks enjoyed a long period of growth, so this thesis had never been tested.
A more robust theory regarding BTC prices also emerged during this period. The Bitcoin software is programmed to reduce the amount of newly minted BTC entering circulation by half every 210,000 blocks, or approximately every four years. The first one took place in 2012 and the next in 2016. Observable cycles emerged where the price inflated exponentially higher each time. As such, there was great anticipation surrounding the next halving in May 2020, even as the markets languished in the “crypto winter” of 2018 and 2019.
In the months leading up to the third Bitcoin halving, the Covid-19 pandemic hit. All the speculation that Bitcoin could act as a safe haven asset in the event of a financial crisis proved to be just that – speculation. In the same week that the New York Stock Exchange was forced to halt trading to act as a “circuit breaker” on plummeting stock prices, the value of Bitcoin dropped by more than 50 percent in just two days. Far from acting as a safe haven, BTC had performed in lockstep with other risk assets.
Later, data collated by Van Eck showed that 2020 had upended previous expectations by establishing a correlation between Bitcoin and traditional asset classes. Although the correlation was still relatively low, it had become much harder to argue the case for Bitcoin as a hedging asset.
Now, with another two years of data to analyze, the trend is evident. Bitcoin's correlation with US equities is increasing year on year. The correlation is so evident in 2022 that the chart makes it easy to discern the “black swan” event in November when FTX collapsed, briefly – but very distinctly – untethering the digital asset markets from stocks.
Furthermore, long-term analysis also shows that BTC is increasingly showing an inverse correlation with the US dollar. This relationship further underscores the categorization of Bitcoin as a risk asset rather than a safe haven asset that could be used to hedge against stock market volatility.
Any return to normal following the pandemic has been blighted by other macroeconomic events – most notably, the Russian war in Ukraine, soaring energy prices, and the global financial downturn. Governments and central banks have reacted by raising interest rates as a way of curbing inflation.
Bitcoin prices, along with stock prices, are at the convergence of many complex forces involved in these events. Which forces could be pushing Bitcoin towards a stronger correlation with equities?
Undoubtedly, the inflow of institutional participation to the digital asset markets since around 2020 has been a huge contributing factor to Bitcoin’s increasing correlation with the stock markets. According to data compiled by Coinshares, institutional investors poured $6 billion into digital asset products in 2020, an increase of over 800 percent compared to the previous year. In 2021 this investment rose another 37 percent before dropping due to the sell-off last year.
Furthermore, through this institutional participation and growing acceptance of digital assets, Bitcoin has become more embedded into the global financial markets in various ways. For instance, Coinbase is now a listed company, and as a crypto trading platform, its stock price is known to have a heavy correlation with Bitcoin. In January of this year, as Bitcoin made a surprise rally following the collapse of FTX two months earlier, Coinbase shares jumped accordingly. Coinbase is listed on NASDAQ, and as such, the “Bitcoin effect” on its stock prices will also be mirrored in any index that tracks the performance of NASDAQ companies.
Similarly, the creeping presence of BTC on corporate balance sheets will also play a part in creating a further correlation between Bitcoin and the global equity markets. The four public companies with the largest BTC balances – MicroStrategy Inc., Marathon Digital Holdings, Coinbase, and Square Inc. – are all listed on NASDAQ. The rise and fall of Bitcoin will have a direct impact on the valuation of these companies, with the extent depending on their exposure. This also explains why the NASDAQ Composite index frequently shows a slightly higher BTC correlation than the less tech-heavy S&P 500, as visible on the correlation chart shown above.
With the lines between the digital asset and equities markets becoming increasingly blurred, the most straightforward explanation for the correlation is that the markets now share an investor profile that is more similar than it has been at any point in Bitcoin’s history. Conversely, while Bitcoin was a niche asset traded among a relatively smaller group of mostly retail investors, it was better shielded from any macroeconomic forces causing volatility in the global markets.
Another factor that could be affecting the BTC-stocks correlation is energy prices. The Bitcoin software incorporates a mining difficulty algorithm, which is a security mechanism designed to prevent any one entity from taking over the network with an abundance of computing power. As Bitcoin has increased in price over the years, it has attracted more miners to the network, causing the algorithm to keep cranking up the difficulty. Whereas in the early days of Bitcoin, it was possible to mine BTC using a home rig based on GPUs, mining now requires specialist hardware and consumes vast amounts of energy.
As such, mining profitability is heavily linked to the price of energy and, thus, some argue that mining profitability indirectly impacts the price of BTC. The thesis is that if mining profitability falls, more miners are forced to sell their rewards as fast as they are earned, creating downward pressure on prices. The bearish market in 2022 forced mining companies to sell 100% of their mined Bitcoin, fueling the debate over whether miner sell pressure has contributed to the downturn.
Similarly, many firms, particularly in the manufacturing sector, are seeing their bottom line shrink as energy costs have soared. Since BTC and corporations alike are at the mercy of the energy markets, this is another factor likely to be driving correlation.
One interesting side avenue to this argument is that not all digital assets share Bitcoin’s reliance on energy, yet it is still often the case that Bitcoin price movements lead the digital asset markets. However, Ethereum’s recent move to proof-of-stake has reduced its energy expenditure by 99.9%. Over time, it will be intriguing to see whether Ethereum’s switch also reduces ETH’s historical correlation with BTC.
While there are compelling arguments to support the theory that Bitcoin is now correlated to the global equity markets, there are still forces at play that could cause the flagship asset to move off on its own trajectory. Most notably, Bitcoin’s own market cycles linked to the periodic halving.
Given the next halving is not due to take place until 2024, proponents of the market cycles theory would argue that 2022 and 2023 always stood to be bearish periods due to their position in the cycle. If this theory holds, any rally in the stock markets before 2024 would have a negligible impact on BTC prices.
There is also a valid argument that headline-making events in the digital asset sector have the power to pull prices in their own direction, independent of the global markets. This has happened several times in the past and can create upward or downward pressure depending on the event.
For example, when PayPal announced in October 2020 that it was planning to integrate crypto, it caused BTC prices to jump by 8% in a single day. Conversely, negative news like the FTX debacle has the opposite effect, independently of whatever else may be making headlines.
Over the long term, institutional adoption of Bitcoin is creating an increasing correlative effect with stocks and, conversely, an inverse correlation with US dollars. If institutional take-up continues over the coming years, it seems highly likely that Bitcoin will no longer return to its previously uncorrelated state. Therefore, for portfolio management purposes, BTC can be considered as a risk asset. As such, it can serve as a diversifying tool for other risk assets, or as a hedge against US dollars.
However, if the theory that Bitcoin undergoes its own price cycles holds water, it is to be expected that the level of correlation with stocks could ebb and flow over time along with these cycles and corresponding investor interests. It is also notable that intrinsic volatility in the digital asset markets can cause them to uncouple from other risk assets in the short term. But on the other hand, short-term shocks to the stock markets – as happened at the onset of the pandemic – appear to create a sharp increase in correlation.
Given there are competing forces at play, it may be difficult to use correlation as a way of capturing investment opportunities in stocks. However, correlation is observably higher in stocks and indices that have a stronger relationship with digital assets. Therefore, fund managers can focus on the proximity to digital assets as a way of assessing the likelihood and strength of any stock or index correlation.
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