Bitcoin Prices Are Less Independent Than You Think
Inside the world of cryptocurrencies, some truths go unquestioned: 1) centralization is terrible, 2) fixed money supplies are great, 3) cryptocurrencies are uncorrelated from stocks.
The last “truth” is now in question.
Many analysts, myself included, have raised questions about Bitcoin following the stock market before, but none of us made the case as strongly as Forbes contributor Clem Chambers.
Chambers recently used intraday trade charts to show that Bitcoin prices often follow the same patterns as the Dow Jones Index. (Source: “Bitcoin Price Is Correlated To Stocks,” Forbes, May 8, 2018.)
In other words, he showed that Bitcoin and the Dow are connected.
He offered a specific Dow chart to back up his claims. It showed that a rise in the Index often precedes a rise in Bitcoin prices and vice versa.
As for the “why” of the situation, there’s a simple explanation: It’s the Federal Reserve.
Ever since the 2008 financial crisis, the central bank has tried to tempt investors into something known as a “carry trade”. This simply means that Wall Street borrows money at record low interest rates to invest in high-yield assets.
If you’ve watched the markets for the last decade, you probably recognize it.
The Fed pumped so-called “easy money” into the economy, and the result was a stock market boom from 2009 to now. But that world is falling apart. The Fed raised interest rates five times in the last two years.
“Trillions of levered QE dollars have pushed the stock market to epic highs,” wrote Chambers. “This process is being unwound and because of that the markets have become extremely volatile.” (Source: Ibid.)
Why Should Investors Care?
Scroll down the Dow Jones Index and you’ll see only 30 names, all of them steeped in American history. It’s an exclusive list of blue-chip stocks—Boeing Co (NYSE:BA), Caterpillar Inc. (NYSE:CAT), McDonald’s Corporation (NYSE:MCD)—that appear in almost every major portfolio in the world.
That amount of liquidity makes the Dow extremely sensitive to changes in the interest rate. Bitcoin, on the other hand, takes some time to respond because trades don’t happen instantly—they sometimes take several hours, if not days.
This lag time in Bitcoin trading presents an opportunity. Studious traders can watch the Dow Jones to see if it breaks a tough price point, then execute a similar trade for BTC/USD.
But let’s zoom out to 10,000 feet for a moment.
There’s a bitter irony in the Dow influencing what happens to Bitcoin prices. Satoshi Nakamoto (the mysterious creator of Bitcoin) would probably shudder at the thought. After all, he made Bitcoin to replace the existing financial system, not to operate as a cute subdivision.
Bitcoin enthusiasts often claim this anti-Fed attitude is what makes cryptocurrency so invaluable.
What makes cryptocurrency special is the ability to decentralize information structures, build smart contracts, or create an infallible record of something.
I’m a big fan of these non-political uses of cryptocurrency. Unfortunately, big chunks of the community remain obsessed with toppling central banks and other such cartoonish goals.
If anything, the link between Bitcoin and the Dow shatters any myth that BTC/USD prices are driven by an earnest evaluation of cryptocurrency adoption. It isn’t. Traders don’t care whether people are using Bitcoin to pay for Subway sandwiches—they care about the potential return.
Speculation, more than anything else, is driving both Bitcoin prices and the Dow Jones Index through the roof. I don’t think the same is true for Ethereum or Ripple, both which provide value to real businesses.
If you’re trying to make a quick buck trading cryptocurrencies, this intraday correlation is something you can use to your advantage. However, I am a fundamentals/strategy guy. I like to evaluate the end game of a cryptocurrency.
So, my favorites are, and will always be, those investments that actually do something in the real world.