Crypto Market vs Stock Market: Exploring an Interesting Relationship

There are several camps in the market. One is trying to separate itself completely from so-called "funds", and the other is working with a keen eye on them. But, no matter how hard either camp tries to fence itself off, the connection between them exists.

To properly illustrate this, I will articulate my point of view in this article.

The question of whether there is a correlation can be answered by looking at the chart of the stock and cryptocurrency market movement after the FED hiked the discount rate on December 14 last year. Since that day, it has become 4.5%. The stock market reacted to this with a decrease of ~7%. The price of Amazon, Netflix, Chevron, and other giants' shares had dramatically decreased (however, US blue chips lose trillions of dollars of capitalization after each rate hike by the FED). Like the stock market, cryptocurrency declined. The price of BTC decreased from $18,400 to $16,250.

Talkative enough, isn't it? But is it possible to argue about a directly proportional relationship? Probably not.

Confessing the principle of "knowing to understand", I will tell you what factors I considered and how I took them into account. After all, by understanding the interconnection of assets, we can predict with a high probability the further movement of the price of an asset.

Why are we considering the discount rate?

With the depreciation of money and a low discount rate, companies could invest free funds in more reliable assets that are not affected by inflation. Bitcoin was considered as such, a kind of “digital gold”, which attracted the capital of “whales”.

In addition, taking into account the discount rate (sorry for the pun), loans are issued in banks. As this figure rises, companies are reluctant to borrow and end up with much less capital. The pace of production and profits are falling, which reduces the value of shares and, accordingly, stock indices.

Also, incentives to invest in various assets, including digital ones, are decreasing. That is why, in 2022, companies began withdrawing funds from the cryptocurrency market, which caused it to plummet. The graphs of the total cryptocurrency market capitalization clearly show the bearish mood of investors.

Let's agree on terms

Correlation is a statistical relationship between two or more figures, parameters, and values - in our case, two different markets. Usually, those instruments, the prices of which change in one direction, are called correlated prices. That is, if one asset rises in price, then the second rises in price, and vice versa. This is an example of a positive correlation. There is also a negative correlation: when the price of one asset increases, the price of the second decreases.

The correlation can be stronger or weaker, the strength is usually measured as a percentage. It is traditionally considered that a correlation of up to 50% is a weak relationship, 50% -70% is medium, and 70% -100% is strong.

When talking about the stock market, many people think of the S&P, NASDAQ, and Dow Jones indicators. In my opinion, it is more correct to talk about the Russell 2000 index, which is more relevant for high-risk assets, small caps - so-called small-capitalization companies, including cryptocurrencies.

Background

Bitcoin appeared in early 2009, in fact, as a response to the global crisis - primarily in the securities market. This was largely a reaction to the appearance of signs of a global recession beginning, a policy of quantitative easing and uncontrolled emission of money by central banks that control the world's reserve currencies, to inflation of financial bubbles around the world.

At first, the capitalization of the crypto market was microscopic, and institutional investors and big businesses did not know how to value this asset, because it did not fit into any traditional classifications. There was no correlation between bitcoin and the traditional stock market at that time.

In 2017–2019 the correlation between the daily fluctuations of the Bitcoin rate and the S&P 500 was only 0.01, almost absent; but in 2020-2021 this figure jumped to 0.36. The correlation of BTC and ETH intraday volatility with the volatility of major US indicators (S&P 500, Nasdaq, Russell 2000) is now 4-8 times higher than before the pandemic.

When everything changed

Both the capitalization of the cryptocurrency market and the degree of its synchronization with the stock market increased during the pandemic, after the unprecedented “pumping” of markets with liquidity by central banks in response to the corona crisis in 2020. Since the second quarter of 2020, stock markets returned to growth, as well as the cryptocurrency markets, amid favorable global financial conditions and higher investor risk appetite. At this time, another BTC bull cycle began, institutional investors got used to the topic of cryptocurrencies, and capital from traditional stock markets began to arrive in the crypto market. From this moment, we can talk about the emergence of a correlation between Bitcoin and the stock market.

Today, bitcoin has become risky, somewhat specific, and similar in many ways to ordinary assets. But there's something else that's important to mention. This was facilitated by the entry into the crypto capital market from the stock market. Various investment funds and large companies (for a long time existing on the market or newly created ones) have also entered the crypto segment. Capitalization soared to a maximum, approaching 3 trillion dollars. Thus, since 2020, bitcoin has become the same financial instrument as all the others. From now, we have a high correlation with the stock market.

What's next?

When I hear that the crypto market is going through hard times, I remind that traditional markets are also falling. Without going into detail on why and how far traditional markets will fall, what is important is that the fall will continue, and it will take some time before the recovery begins. Thus, the traditional fund pulls BTC with it.

The prospects of correlation are rather vague: they are influenced by many variables. If the risks in the cryptocurrency market (mining costs, government restrictions on the cryptocurrency industry, etc.) grow, and the economic and political situation in the world (inflation, the FED’s discount rate, geopolitical conflicts, etc.) worsens, both markets will continue to fall. If not all indicators worsen, then a divergence in trends is possible.

And yet, I believe that for some time we will still observe a correlation with the securities market. Then, as the crypto market grows stronger and confidently enters financial systems and models, including at the state level, we will see not only a correlation but also an inverse correlation with the fund market.

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