Traditional markets have risen amid fears that inflation is back and interest rates will have to rise. Bitcoin (BTC) is also down. Is there a connection?
As many countries start to return to a semblance of normal, at least in the economic sense, inflation fears have gripped the markets. In the 12 months leading up to April, US consumer prices leaped 4.2% in the most significant increase since the 2008 financial crisis.
In the UK, inflation doubled in April compared to March, with a rise of 1.5%. Countries in the EU are waiting to see who will be the first to jump with an interest rate hike following news that inflation is up to 2% across the bloc.
As this news has been unfolding, there’s evident trepidation in the stock markets. The Federal Reserve has committed to keeping interest rates low in the US, indicating that it’s prepared to tolerate at least a short-term increase in inflation. Some reports state that officials have rushed to try and contain the inevitable fallout among financial firms. However, all major indices have experienced some volatility over recent weeks.
The cryptocurrency markets have been moving at a characteristically breakneck pace over the past weeks. Except that, in a departure from the significant bullish movements we’ve recently seen, crypto prices tumbled dramatically in May. By Wednesday, May 19, BTC had lost over 45% of its value compared to where it started the month.
Are all these things related? The narrative has always been that Bitcoin as an asset doesn’t correlate to the stock markets, and neither is it subject to broader macroeconomic influences. While that may be true to some extent, there are also deeper considerations.
Despite their digital nature, cryptocurrencies don’t exist in a vacuum. When Bitcoin was dominated by the more unpredictable retail investor market back in 2017 and 2018, stating that crypto operates independently of the stock markets was a relatively uncontroversial observation.
However, now that many investors from traditional finance are dipping a toe into digital assets, it wouldn’t be unreasonable to expect the markets to become subject to some of the same forces.
By this logic, investors may be unwilling to continue exposing themselves to cryptocurrency’s volatility if the markets plummet. But there’s always the argument that investors will treat Bitcoin as they treat gold—a hedge against prices falling in other assets.
In the 12 years that Bitcoin has been in operation, its performance as an asset has never been tested through a serious, sustained down cycle in the broader markets. In fact, in the few instances where stock market dips happen, such as March 12, 2020, Bitcoin prices tend to correlate. Albeit in a typically more dramatic fashion.
So does that mean that the prospect of inflation means ongoing gloom for the cryptocurrency markets? No.
Other factors push Bitcoin and cryptocurrency prices against the direction of market forces. It would be impossible not to mention Elon Musk, who seems to have a capricious influence over Bitcoin prices based on recent events. But there’s a lot more going on.
BTC prices tend to follow patterns, and most analysts agree that the patterns are strongly correlated to halving events, where the mining reward gets cut in half and introduces more scarcity.
Pseudonymous cryptocurrency analyst PlanB developed a startlingly accurate Stock-to-Flow model based on BTC’s halving patterns. Despite a recent divergence of BTC price from the model, possibly due to the effect of COVID-19 on the economy, the correlation remains strong. And, if the model is to be believed, the current Bitcoin bull cycle is only just getting started.
But even without applying any sophisticated models to the price cycles, the trend post the 2012 and 2016 halvings was that it took around 16-18 months for prices to reach a peak. We’re currently only a year out from the latest halving in 2020, implying that it may be too soon to call a top or bottom price for 2021.
Finally, it’s also worth remembering that individual cryptocurrencies often have micro-economic events that operate independently of the broader crypto and traditional markets.
Even before the cryptocurrency markets started their dramatic fall in May, ETH outperformed BTC on price in relative terms. And, during the most recent tumult, coins such as Cardano’s ADA and Polygon’s MATIC managed to stay shielded from the broader crypto price drop.
In the end, it’s hard to say whether crypto would couple or decouple from the markets if interest rates start to climb. However, since the beginning of 2020, there appears to have been a much stronger correlation of BTC prices with USD inflation than in previous years.
It seems relatively inevitable then that whether the correlation is a direct or inverse one, BTC prices are now more connected to real-world events than they have been at any time in its history.
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