Historically, Bitcoin (BTC) and similar cryptocurrency assets were considered to be uncorrelated assets, due largely to their niche nature and relevance to a vanishingly small number of people.
However, the crypto market is now entrenched in the investment mainstream, as adoption rates continue to increase across a broad range of applications. While BTC is leading this trend, the emergence of third-generation blockchains and tokens is raising awareness further, while also increasing the scope of the technology markedly.
Third generation blockchains are having a seismic impact on the market, as they’ve been designed to resolve the scalability issues facing earlier iterations and are actively improving assets like BTC.
As BTC in particular benefits from increased demand and adoption rates, we’re also seeing the asset share a higher correlation with stocks. But is this a long-term trend for investors to consider? Let’s find out!
Bitcoin’s Correlation With Gold and Stock
Bitcoin has been historically described as ‘digital gold’, with this having much to do with the age-old notion that BTC can mirror gold’s effectiveness as a secure store of wealth during a wider economic downturn.
Economists believed that this has gradually created correlation between BTC and gold prices during times of economic tumult, and it appeared as though this was borne out during the coronavirus pandemic.
In the final quarter of 2020, JP Morgan’s published global strategy notes also highlighted that money began to flow out of gold and into BTC as a potentially superior future store of value.
However, this contention has always been challenged by some economists, who believe that Bitcoin’s innate volatility, intangible nature and continued integration into the financial markets make it unsuitable as a stable store of wealth.
Such analysts have also observed that BTC is more closely correlated to macroeconomic events and factors, meaning that the asset has more in common with copper than precious metals like gold or silver.
More specifically, Bitcoin should be considered as a viable ‘risk-on’ asset, rather than a vehicle through which to hedge against market and economic risks.
If we observe more recent market demand at the end of 2020, we also begin to see an increasingly negative correlation between BTC and gold. For example, May 2021 saw a widespread firesale across the crypto markets, while demand for gold and the asset’s underlying price experienced a marked hike.
What’s more, BTC’s movements are now moving more closely in tandem with US stocks, with the 40-day correlation coefficient for Bitcoin and tech-led Nasdaq 100 having peaked in January of this year.
In fact, the coefficient reached an unprecedented 0.66 during this period, the highest single point in data collated by Bloomberg since 2010.
A similar trend was evident between BTC and the S&P 500, as both asset classes slumped in early January before subsequently rebounding.
Why are Stocks and Crypto Assets Becoming Increasingly Correlated?
Interestingly, BTC’s price has broadly moved in tandem with the Vanguard Total World Stock ETF price since 2017, but the actual level of correlation between Bitcoin and indices like the S&P 500 was ranked as low as 0.01 by the IMF.
This is indicative of independent price movements, with assets considered to move in total synchronicity usually boasting a correlation value of 1.
As we’ve already touched on, however, this trend began to change in 2021, as central banks reacted to wider and sudden macroeconomic changes by flooding the market with liquidity.
This shift helped to drive correlation between BTC and the S&P 500 up to 0.36, as both crypto assets and stocks began to move in the same direction simultaneously.
The increased correlation between these two assets can also be partly attributed to the way in which macroeconomic events are now impacting Bitcoin.
While the global and decentralised nature of BTC has always made the asset susceptible to factors such as fiat currency volatility and monetary policy, Bitcoin’s increased popularity and accessibility among investors has heightened this trend further.
Generally speaking, demand for BTC can fluctuate wildly even in real-time, as various macroeconomic outcomes impact the asset’s ability to add value or generate a return.
So, periods of sustained economic growth and wealth accumulation will see BTC and similar assets adopted at increased rates, whereas such tokens may be eschewed in favour of risk-averse alternatives like government-backed bonds during times of economic uncertainty.
Stock traders often adopt a similar approach depending on the prevailing macroeconomic climate, further highlighting the correlation between shares and BTC and the impact of market sentiment on each asset class.
The Last Word – What Does This Mean for the Financial Marketplace?
Even the IMF has warned that sentiment in equities and crypto tokens is increasingly connected, causing a growing number of investors to treat these assets in the same way.
In short, both are now viewed as ‘risk-on’ assets that are increasingly malleable to macroeconomic developments, and largely unsuitable when looking to hedge against a specific market risk or wider economic downturn.
Ultimately, the broader message here is that cryptocurrencies like Bitcoin should no longer be considered as secure wealth stores, particularly when attempting to hedge against a decline in equities and share prices. Instead, stocks and BTC should be considered as similar assets from the perspective of diversification, with gold and bonds used as preferred ‘safe haven’ assets.
Another key consideration for investors is that crypto’s innate volatility is now spilling into the global equity markets. This is due to the transference of sentiment from one asset class to another, creating a type of contagion effect that could dramatically undermine market stability in the near-term.
This is even more alarming when you consider Bitcoin’s similar correlation to fiat currencies and the emerging markets, which has the potential to spread the contagion effect even further through the financial marketplace.
BTC’s correlation with the MSCI Emerging Markets Index rose to 0.34 in 2021, representing a 17-fold increase on previous years. Given that the emerging markets are already noticeably changeable and volatile, this could create a significant challenge to investors going forward.