Crypto’s correlation with mainstream finance could bring more bleeding soon

Since the start of the year, the crypto market’s performance has been considerably poorer than the S&P 500 and other popular indexes.

There’s no denying the fact that the crypto market has been faced with an obscene amount of bearish pressure over the last eight odd months. Despite this, September has been especially turbulent for the industry, with the price of Bitcoin (BTC) dropping below the all-important $20,000 psychological threshold before forging a comeback. 

While these dips have called into question the asset’s status as digital gold and a hedge against inflation, a key question worth examining is how deeply intertwined the crypto market with the global economy is.

To this point, historic inflation numbers have driven the price of everything under the sun — from fuel to food — to record highs. And, despite the S&P 500, a stock market index tracking the performance of 500 large companies listed on exchanges in the United States, being down year-to-date (YTD), its performance has been better than that of the crypto market by a decent margin.

Charmyn Ho, head of crypto insights for cryptocurrency exchange Bybit, pointed out to Cointelegraph that just like any other market, the crypto industry is currently being subject to volatilities brought about by macroeconomic factors, adding:

“It is definitely fair to say that the global financial landscape has placed a strain on Bitcoin’s prices. With continued liquidity pressure due to quantitative tightening and uncertainty, investors are tending to shy away from risk assets, which in turn is limiting any upside momentum for the crypto market.”

On the recent recovery above $20,000, Ho noted that whether this is a trend reversal — after a recent confluence of on-chain metrics hinted at a bottom formation — or just a temporary attempt to flush out excessive leverage is still too early to tell. Reflecting on historical data, she believes that the prolonged duration of BTC’s current dormancy may indicate the formation of a reliable floor price, which can help pave the way for the next bull trend.

Is crypto’s link with the global economy now inextricable?

Ajay Dhingra, head of research and analytics at crypto exchange Unizen, told Cointelegraph that rising inflation has dramatically decreased the risk appetite of investors for crypto and weakened the global economy to a point where Bitcoin has not been able to keep its promise of a safe haven against inflation. This is largely due to its high correlation with the stock market and unpalatable volatility. 

He added that while the future remains as promising as ever for blockchain technology, due to the crypto market’s deepening link with the broader economy, there may be even more pain for investors in the near term. Dhingra noted that it is always consumer sentiment that dictates any market, adding:

“Right now, the world is going through a massive crisis because of the Ukraine war, rising prices and weak economic activity, which has irked the retail sector. But in the long run, the innovation brought forward by blockchain technology will inevitably break the correlation.”

In Ho’s opinion, the existing correlation is likely to persist. However, it is hard to predict its extent since the economy’s recent downturn has had implications of unimaginable proportions on investors and traders worldwide.

Similarly, she pointed out that prevailing macroeconomic conditions have taken an unprecedented toll on the market sentiment of risk-on and risk-off investments as well, adding that if the economy sees a further decline, investors across the board will continue to lay off assets like crypto and move toward fiat-centric offerings like government bonds. She added:

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“I think with cryptocurrencies becoming more widely accepted, links between traditional finance and the crypto economy can definitely be drawn. However, these two still maintain some form of independence from one another since they have vastly different features and uses.”

Frederic Fernandez, the co-founder of DEXTools — a blockchain data aggregation platform — believes that even though economic conditions across different markets are affecting Bitcoin quite heavily, when the dust finally settles, not only will people understand the advantages of crypto as a refuge from the traditional finance sector but the market at large could see a solid uptrend. He added:

“Big players are now into crypto too and are building their future portfolios, they are taking advantage of this market to create good strategies for their funds and customers, but it will take time to see the consequences when the market will be more mature.”

What happens now for the crypto market?

Despite Bitcoin rallying over the last few days, many analysts believe that it is highly unlikely that the currency — as well as the crypto market at large — will be able to muster the kind of momentum that it needs to move past this dull phase any time in the foreseeable future. 

For example, Akeel Qureshi, chief marketing officer for decentralized finance (DeFi) protocol Hubble Protocol, told Cointelegraph, “According to the Bitcoin maxis, this is the environment in which the asset was meant to thrive. While that theory was formulated long before players like JPMorgan bought in, currently, there just does not seem to be much good news on the horizon,” adding:

“Bitcoin is tied to the policies of the Federal Reserve.”

He noted that while Bitcoin has long been touted as an inflation-proof asset — a narrative which still holds true depending on when one bought the token — at the moment, it is witnessing falling prices, especially as the job market continues to weaken.

Qureshi, however, stated that not all cryptocurrency prices are as inextricably linked to the global economy as Bitcoin. He believes that Ether (ETH) has already started to pull away from BTC ahead of its long-awaited merge to a proof-of-stake consensus model, which is set to take place next week, adding:

“This is potentially heralding the so-called ‘flipping,’ where growth in ETH begins to outpace that of Bitcoin. Meanwhile, active traders are finding good opportunities among altcoins and smaller cryptocurrencies on the vast array of blockchains and decentralized networks that now exist.”

Lastly, he noted that the stablecoin market remains incredibly strong regardless of rising interest rates because it is still impossible to find a bank capable of giving an interest rate on cash that is higher than the prevailing inflation. “In decentralized finance this is possible on U.S. dollar-backed stablecoins. As such, for those willing to explore, crypto has boundless opportunities.”

Could a trend reversal be possible for BTC?

According to some analysts, the recent decline in crypto prices hasn’t been spurred by rising inflation but by soaring interest rates that have been hiked to help wipe out excess liquidity in the market, clamp down on inflation and strengthen the U.S. dollar. Furthermore, higher interest rates also equate to better treasury yields and increased investment from foreign bond buyers. Therefore, a trend reversal in the near term may be difficult, albeit not impossible.

That said, over the past decade, Bitcoin has largely outperformed most stocks while gaining mainstream acceptance by many entities in traditional finance. Investment giant BlackRock recently started pumping its client’s money into the digital asset, suggesting a potential uptick in crypto’s future. Also, it is worth noting that the last time BTC dipped below $10,000, it swiftly proceeded to scale to an all-time high of $69,000.

Lastly, some experts believe that Bitcoin could soon continue to lose its strong correlation with the stock market, highlighting that over the last 14-day stretch, people have been selling on the S&P 500 while BTC has gained nearly 10% value. Another thing that seems to be favoring Bitcoin is that major fiat assets such as the euro, the Great British pound and the Japanese yen are sitting at record lows in comparison with the U.S. dollar.

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Regarding this point, Ben Caselin, vice president of global marketing and communication for cryptocurrency exchange AAX, told Forbes that there is currently a very strong relationship between the U.S. dollar’s price action and that of Bitcoin, adding that while the dollar has shown decent strength over Q2 2022, any drawdowns could spur a rally for Bitcoin in the near term. 

Thus, as we head into a future fueled by financial uncertainty, it will be interesting to see how things play out for the crypto market, especially since there seems to be little respite coming from the traditional finance front anytime soon.