Why is it connected to the stock market?

In today’s increasingly connected financial world, cryptocurrencies such as Bitcoin (BTC) continue to generate significant interest and spark lively debates. The pioneering digital currency, once heralded as a revolutionary force, is now facing scrutiny for its confusing connection with traditional financial markets.

This article delves into the factors behind Bitcoin’s correlation with the stock market, and examines whether it can maintain its revolutionary status in the ever-changing economic landscape.

Trace the correlation

Bitcoin has long been celebrated for its decentralized nature. Nevertheless, its correlation with stock market fluctuations calls into question its true independence. To evaluate Bitcoin’s revolutionary impact on finance, it is crucial to examine this confusing connection.

Institutional investment

An important factor that promotes the correlation is institutional investment. Large firms, which invest in both stocks and cryptocurrencies, may inadvertently create a link between the two markets. When institutional investors buy or sell BTC, their actions inadvertently align with the trends in the stock market. For example, during the COVID-19 pandemic, companies like MicroStrategy and Tesla invested heavily in Bitcoin, driving up its price along with the stock market’s recovery.

Market sentiment

Market sentiment also plays a role. Investors, influenced by emotions such as fear and greed, often react similarly to different markets. Consequently, when stocks plunge, panic can spread to Bitcoin, while exuberance can lift both during a bull run. The crypto boom of 2017, fueled by the enthusiasm of private investors, exemplifies how market sentiment can affect asset prices. As Bitcoin’s value rose, so did shares of blockchain-related companies, revealing a connection between the two markets.

Macroeconomic forces

Macroeconomic forces, such as interest rates and inflation, can affect both stocks and Bitcoin. For example, rising inflation can cause investors to seek assets that retain value, increasing interest in both stocks and cryptocurrencies. In periods of low interest rates, investors can seek higher returns in riskier assets, driving up prices in both the stock and crypto markets.

Bitcoin: Safe haven or risky asset?

As the debate over Bitcoin’s status as a safe haven or store of value intensifies, it is important to analyze its historical performance.

Stock exchange fluctuations

In times of economic turmoil, Bitcoin has shown mixed results. In some cases it has outperformed traditional markets, while in others it has mirrored their decline. For example, during the 2008 financial crisis, Bitcoin’s value remained relatively stable, while traditional assets experienced significant losses. But in March 2020, as the COVID-19 pandemic wreaked havoc on global markets, Bitcoin’s price also plunged, raising doubts about its safe-haven status.

Volatility comparison

Compared to gold, a classic safe haven, Bitcoin shows higher volatility. This characteristic often deters risk-averse investors, who prefer the stability of traditional assets in turbulent times. The crypto market crash of 2017-2018 serves as a reminder of Bitcoin’s volatility, with its price falling from nearly $20,000 to around $3,000 in just over a year.

The road to Bitcoin disconnection

To realize its revolutionary potential, Bitcoin must break away from stock market influences. Several factors may facilitate this disconnection.

Increased adoption

Widespread use of Bitcoin, especially by individual investors, may dilute the impact of institutional investments. As more people use BTC for daily transactions, its value may become less tied to traditional markets. Countries like El Salvador, which has embraced Bitcoin as legal tender, exemplify this growing adoption trend. In addition, payment processors such as Block and PayPal allow users to buy, sell and trade in Bitcoin, further promoting mainstream acceptance.

Regulatory clarity

Clearer regulations can increase investor confidence, and encourage participation from both private and institutional investors. As the cryptocurrency market matures, regulatory clarity can foster a more stable environment, minimizing the impact of stock market trends on Bitcoin. The United States Securities and Exchange Commission (SEC), for example, has been working to provide clearer guidance (and enforcement) on digital assets, while countries such as Japan and Switzerland have already implemented comprehensive regulatory frameworks.

Technological advances

Technological advances, such as improvements in scalability and privacy, can also promote disconnection. By addressing concerns related to transaction speed and security, this development could attract a wider range of investors and further diversify the market. Innovations such as the Lightning Network, which improves Bitcoin’s transaction capacity, and Taproot, which improves privacy and smart contract capabilities, demonstrate the ongoing efforts to refine the technology behind Bitcoin.

New competitors

The rise of alternative cryptocurrencies, or altcoins, may also contribute to Bitcoin’s disconnection from traditional markets. As new digital assets with unique use cases gain traction, they can create their own market dynamics, reducing Bitcoin’s overall influence on the crypto market. For example, Ethereum, with its smart contract functionality, and stablecoins like Tether, which are tied to traditional currencies, offer different value propositions that can affect their correlation with the stock market.

Towards a disconnected future

Although Bitcoin’s correlation with the stock market raises doubts about its economic independence, the potential for decoupling remains. Factors such as increased adoption, regulatory clarity, technological advancements and new competitors may eventually free Bitcoin from stock market influences, allowing it to achieve its revolutionary ambitions.

But until this decoupling occurs, the true extent of Bitcoin’s impact on the global economy remains uncertain. As the cryptocurrency landscape continues to evolve, it will be critical for investors and regulators to closely monitor these developments to better understand the future trajectory of Bitcoin and its role in the financial world.