When Bitcoin debuted 12 years ago, there was clearly a lack of correlation between digital assets and equities. It wasn’t long before market developments materialized into a tangible correlation between the two. Today, trading the world’s first cryptocurrency and transactions within traditional equity markets appear to be going hand-in-glove.
The correlation has become more evident, driving many global financial bodies to offer solutions and set rules to regulate the intersection of two similar, yet different, economic worlds. As an asset class, cryptocurrencies have moved from the fringes to the mainstream, increasing the potential of a spillover effect in investor sentiment on other asset classes, especially equity.
In fact, crypto’s association with stocks has even risen higher than that between stocks and other assets such as bonds and gold, according to an IMF report in 2022. In simple economic terms, supply and demand are the main drivers behind the prices of products and services, not least the value of equities. Bitcoin trading also adheres to the same principle given the fixed supply of 21 million of them.
In addition to supply and demand, various other factors can shape the relationship between crypto assets and equities, including monetary policies, political instability, economic conditions and institutional investments. From late 2021 to mid-2022, these factors stood at the crossroads of Bitcoin and equities globally and had a more tangible impact on American and Asian markets.
According to the IMF, crypto and financial markets in Asia were worlds apart prior to the pandemic. Over the past year or so, the lines between the two have become blurry and additional regulatory measures seem to be necessary. For example, the correlation between Bitcoin and the Indian stock markets has grown 10-fold in the wake of the pandemic.
Only bound by blockchain
Another interesting market sentiment is that most investors are equating Bitcoin or crypto to tech stocks due to the rapidly rising adoption of the underlying blockchain technology. The belief from an investment point of view is that blockchain provides utility, contrasting Bitcoin and its traditional counterpart gold, which don’t.
This mindset has led investors to recognize that Bitcoin is more than a currency or digital proxy for gold, but is built on technology that will power the upcoming web3 and DeFi applications. But does this mean that equities and cryptocurrency need to be treated the same?
Well, this is hard to answer due to the nascent nature of the crypto industry. Digital assets still require more time to develop as their own distinct asset class. As crypto matures and its market value fluctuates between hundreds of billions to trillions of dollars, it will expectedly gain more and more popularity among individual and institutional investors.
The next couple of years will see crypto having a life of its own, with a unique identity and market attributes, not just emulating equities and tech stocks. Nevertheless, the alignment of stocks and crypto is not all that bad as it presents traditional investors with a new way to diversify their portfolios.
What should investors do?
Nothing really. No matter how closely crypto tracks the stock market, it is a volatile and risky asset.
The only thing to note is to not jump the gun when short-term market gyrations happen due to CPI data stats, employment updates, uncertain geo-conflicts or the occasional Musk tweet that can happen. More than ever, the developing crypto-stock co-movement necessitates a holistic framework to regulate the financial market through government policies and help mitigate the risks associated with investment. R
Regulatory efforts should be accompanied by crypto literacy initiatives to inform investment decisions and eradicate the anonymity of this nascent asset class. Only time, development and adoption will tell how closely the linkages of crypto and equities will continue.
– The writer is CEO, DIFX Technology.
