Cause and effect: Will the Bitcoin price drop if the stock market crashes?
The year 2009 was marked by both the genesis of Bitcoin and the United States stock market starting an unprecedented bull market — one that’s continued almost uninterrupted since. However, murmurings of a crash are always present, and the noise has recently been getting louder.
Against the backdrop of COVID-19 refusing to go away, stocks keep pushing higher, backed by an unprecedented amount of government support. But now that quantitative easing policies are no longer being implemented, is the talk of a stock market crash justified?
If so, this could bring unfortunate news for Bitcoin (BTC): It could be argued that there are signs of a strong correlation between Bitcoin and stocks. So, what may happen to crypto if the bottom falls out of U.S. equities?
How likely is a crash?
Taking crypto out of the picture, the increasing speculation that a crash is imminent does hold some merit. In June, the inflation rate in the U.S. was significantly higher than expected. In the meantime, the government continued to issue bonds and accrue more debt to the point that there’s now talk of raising the debt ceiling.
The justification for this is, of course, the ongoing pandemic relief effort. But the government is pumping money into the economy when other signs, such as U.S. stock prices, indicate that the relief isn’t needed. U.S. real estate markets are also surging, while the Federal Reserve has already expressed concerns that investors are becoming increasingly reckless, referencing the appetite for meme stocks and cryptocurrencies as cases in point.
All this money pumping into the economy has to dry up at some point, leading to justifiable speculation that a crash could be the inevitable consequence. Michäel van de Poppe, Cointelegraph columnist and full-time trader, believes that “the expectations of a heavy correction are justified,” adding:
“The chances of a [stock market] collapse are increasing day-by-day, as the markets are getting overheated heavily — not just in stocks, but real estate markets are showing similar signals. [...] The market is going into a bubble phase, created by an insane amount of printing from the Fed, through which the middle class is getting squeezed.”Toya Zhang, marketing manager at AAX exchange, agrees that a crash is coming but urges caution on attempting to predict the timing. “Given how common stock market declines are, and the fact that the market is somewhat overvalued, I think there’s a reasonably high probability of a stock market downturn,” Zhang said. “Nobody can say exactly when that will happen, though.”
Correlated for now, but for how long?
One question is: How linked were the recent market recoveries in both crypto and the stock market back in March 2020? Most stock market analysts were surprised by how fast and furious the recovery was. Although, the fact that the S&P 500 skews heavily to tech companies explains a lot given how quickly the world turned to digital.
But in the crypto space, the narrative was somewhat different. In the absence of any other explanation for the crypto market crash, most people were surprised that Bitcoin had behaved in a way that appeared to mirror stocks. After all, the assumption had always been that BTC was uncorrelated and would act as a hedge against more traditional asset types such as stocks and precious metals.
Based on the most recent experience, history would suggest that if the stock markets were to crash in 2021, the crypto markets would follow. An alternative scenario would be that the stock market crashes and investors immediately move funds into crypto. Even without the benefit of March 2020 hindsight, this seems unlikely. Crypto still has a reputation as a notoriously volatile asset, one that’s untested as a safe haven in a financial crisis.
However, what happens post-crash could make for a more interesting discussion about market correlations. What if, this time around, the stock markets don’t go into automatic recovery mode? This scenario is a reasonable assumption, given that the pandemic effect is now priced into the markets, and there’s a lot less uncertainty than there was in March of last year.
What would BTC do in the event of a prolonged flat or even bearish period in U.S. stocks? The most powerful premise for the “Bitcoin is uncorrelated to stocks” argument is that Bitcoin has its own market cycles — linked to halving — that dictate its price movements in a far more compelling way than any external economic forces. Examining it through this lens, one could speculate that regardless of whether the stock markets had recovered post-March 2020, BTC would have gone on to achieve new all-time highs anyway.
But even against the ever-reliable stock-to-flow BTC price model developed by PlanB, prices have been struggling to stay within the boundary of late. Nevertheless, the recent rally means that the model has held, and prices are currently showing significant promise of a sustainable recovery. So even if tumult in the stock markets were to cause chaos in crypto, there is data that predicts that the BTC market cycles could ultimately resume their apparently iron-clad control of prices.
A struggle of opposing forces
If there is a short-term crash, there is no evidence thus far to suggest that the Bitcoin price will fail to follow. Assuming this occurs in 2021, what will happen afterward could become a struggle between Bitcoin’s market cycles and the effects of a prolonged economic downturn.
However, assuming the effect of the former can outweigh the latter by even an increment, it would make Bitcoin attractive as a safe haven asset (in the absence of many other alternatives). If everything else is going down, BTC only needs to maintain its value to tempt investors. But suppose Bitcoin’s halving cycle proves able to negate the effect of a prolonged market downturn altogether. In that case, BTC could become one of the only assets to offer the opportunity for significant returns during a downturn.
Sean Rach, co-founder of not-for-profit blockchain services firm hi, believes that crypto will ultimately become an attractive asset for alpha seekers. “The growing dissatisfaction with the financial system, as well as the history of all fiat currencies, means the search for alternatives remains a positive factor for the growth of the crypto markets,” said Rach. Meanwhile, Mati Greenspan, founder and CEO at advisory firm Quantum Economics, told Cointelegraph:
“In the short history of the crypto asset class, the token market has largely moved in line with other risk assets like stocks and commodities. They tend to react especially well to central bank money printing. Still, there is a lot more room for growth in crypto since it's largely in the early development phase. So even if we see equities hit a top, I don't think it'll have any sustained impact on digital assets.”Ultimately, it’s worth remembering that crashes are short-term events. They may be painful, but the longer-term outlook is where things get more interesting. Suppose stocks end up in a sustained bear market while the macroeconomy recovers. In that case, it could easily turn into an opportunity for investors to scoop up a bargain once crypto bottoms out. As such, while a short-term correlation could be hard to avoid, there’s every chance that crypto could buck the markets in the long term.