The year 2009 saw the birth of Bitcoin as well as the start of an unprecedented bull market in the US stock market, which has lasted almost indefinitely. However, there are always murmurs of a crash, and the noise has recently become louder.
Against the backdrop of COVID-19’s refusal to go away, stocks continue to rise, aided by unprecedented levels of government support. But, now that quantitative easing policies have been phased out, is the talk of a stock market crash justified?
If this is the case, Bitcoin (BTC) may be in for some bad news: There are indications of a strong correlation between Bitcoin and stocks, it could be argued. So, what happens to cryptocurrency if the bottom falls out of US equities?
How likely is a collision?
Leaving crypto out of the equation, the growing speculation that a crash is imminent has some merit. The inflation rate in the United States was significantly higher than expected in June. Meanwhile, the government continued to issue bonds and incur more debt, to the point where the debt ceiling is being discussed.
The ongoing pandemic relief effort is, of course, the justification for this. However, the government is pumping money into the economy when other indicators, such as US stock prices, suggest that the relief is unnecessary. The real estate market in the United States is also booming, and the Federal Reserve has already expressed concern that investors are becoming increasingly reckless, citing the appetite for meme stocks and cryptocurrencies as examples.
All of this money pumped into the economy has to run out at some point, leading to reasonable speculation that a crash is an unavoidable result. Columnist and full-time trader Michäel van de Poppe believe that “the expectations of a heavy correction are justified,” adding:
“The chances of a [stock market] collapse are increasing day by day, as markets are becoming severely overheated — not just in stocks, but also in real estate markets.” […] The market is entering a bubble phase, fueled by the Fed’s insane amount of printing, which is squeezing the middle class.”
Toya Zhang, marketing manager at the AAX exchange, agrees that a crash is imminent but cautions against attempting to predict the timing. “Given how common stock market declines are, and the fact that the market is somewhat overvalued,” Zhang said, “I believe there is a reasonably high probability of a stock market downturn.” “However, no one can predict when that will occur.”
Correlated for the time being, but for how long?
One question is: How closely related were the recent market recoveries in both crypto and the stock market in March 2020? Most stock market analysts were taken aback by how quickly and furiously the recovery occurred. However, given how quickly the world shifted to digital, the fact that the S&P 500 is heavily weighted toward technology companies explains a lot.
However, the story was a little different in the crypto space. Most people were surprised that Bitcoin behaved similarly to stocks in the absence of any other explanation for the crypto market crash. After all, the assumption had always been that Bitcoin was uncorrelated and would serve as a hedge against more traditional asset classes such as stocks and precious metals.
Based on recent experience, history suggests that if the stock markets crash in 2021, the crypto markets will follow. Another possibility is that the stock market crashes and investors immediately transfer funds to cryptocurrency. This appears unlikely even without the benefit of March 2020 hindsight. Cryptocurrency remains a notoriously volatile asset that has yet to be proven as a safe haven in a financial crisis.
What happens after the crash, on the other hand, could make for a more interesting discussion about market correlations. What if, this time, the stock markets do not automatically recover? This is a reasonable assumption, given that the pandemic effect has now been priced into markets and there is far less uncertainty than there was in March of last year.
What would BTC do if stocks in the United States remained flat or even fell? The most compelling 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 far more powerfully than any external economic forces. Examining it through this lens, one could speculate that regardless of whether stock markets recovered after March 2020, BTC would have gone on to set new all-time highs.
However, even when compared to PlanB’s ever-reliable stock-to-flow BTC price model, prices have recently struggled to stay within the boundary. Nonetheless, the recent rally indicates that the model has held, and prices are now showing significant promise of a long-term recovery. So, even if turbulence in the stock markets causes havoc in crypto, there is data to suggest that the BTC market cycles will eventually regain control of prices.
A conflict between opposing forces
There is no evidence to suggest that if there is a short-term crash, the Bitcoin price will not follow. If this occurs in 2021, what follows could be a battle between Bitcoin’s market cycles and the effects of a prolonged economic downturn.
However, if the former can outweigh the latter by even a small margin, Bitcoin will become more appealing as a safe haven asset (in the absence of many other alternatives). If everything else is falling, BTC only needs to hold its value to entice investors. But suppose Bitcoin’s halving cycle is able to completely negate the effect of a prolonged market downturn. In that case, BTC could become one of the few assets that can provide significant returns during a downturn.
Sean Rach, co-founder of hi, a non-profit blockchain services firm, believes that cryptocurrency will eventually become an appealing asset for alpha seekers. “Growing dissatisfaction with the financial system, as well as the history of all fiat currencies,” Rach explained, “means that the search for alternatives remains a positive factor for the growth of the crypto markets.” Meanwhile, Mati Greenspan, the founder and CEO of Quantum Economics, told us:
“Throughout the short history of the crypto asset class, the token market has largely tracked other risk assets such as stocks and commodities. They are especially sensitive to central bank money printing. Nonetheless, because crypto is still in its early stages, there is a lot more room for growth. So, even if equities reach a peak, I don’t believe it will have a long-term impact on digital assets.”
Finally, it’s important to remember that crashes are only temporary. They may be unpleasant, but the long-term outlook is where things become more interesting. Assume stocks experience a prolonged bear market while the macroeconomy recovers. In that case, it could easily turn into an opportunity for investors to snag a steal once cryptocurrency reaches its bottom. As a result, while a short-term correlation may be difficult to avoid, there is a good chance that crypto will outperform the markets in the long run.