Institutional investors have just warmed to Bitcoin when the pandemic broke out. Now the main reason why they found cryptocurrencies appealing no longer seems to be justified.
Almost four in five institutional investors said they like digital assets like Bitcoin, according to a new survey by brokerage firm Fidelity. The main reason, as stated by 36% of respondents, was that they believed cryptocurrencies were "not correlated with other assets like stocks".
But the economic devastation of the recent corona virus pandemic appears to have destroyed this investment thesis. The wave of destruction has exposed entanglements between digital currencies and the stock market, which are undermining the very reason why investors said they were most interested.
A secret romance
The markets collapsed in mid-March. The S&P 500, a joint exchange measure, fell 14% between March 10 and 12, as did Bitcoin, which lost around 38% of its market value on March 12 alone.
The sell-off revealed that equity and cryptocurrency stocks are at least partially linked, rather than independent. In April, a study by Binance, the world's largest cryptocurrency exchange, found that the correlation between Bitcoin price and S&P 500 performance was "relatively high" at 57% in the first quarter. The correlation was even higher at 64% when Bitcoin was compared to Russell 2000, another stock index with stocks with lower market capitalization.
While Bitcoin boosters may have viewed the unexpected connections between Bitcoin and the stock market as a coincidence – the relationship remains "very unlikely" in the coming months, the author of the Binance report continued – recent market movements point to something else.
Bitcoin and the stock market have moved closer together since April. As the graph below by Coin Metrics, a cryptocurrency data company, shows, the correlation moved up from zero in March when the fidelity study ended to over 0.2 in the past month. (On the vertical axis: "0" means not correlated, "1" means correlated.)
The correlation between Bitcoin and the S&P 500 has increased in recent months. (Screenshot of the coin metric table)
The correlation can become stronger. On Thursday, after Fed chairman Jerome Powell made his bleak assessments of the global economic outlook, investors reacted negatively, causing the stock market to sell out largest since March. The S&P 500 fell 5.7%, and Bitcoin – which had grown 30% for the year despite the March turmoil – fell 6.4% to $ 9,100.
The coincidences between Bitcoin and the ups and downs of the exchange show a hard truth.
The anti-Midas touch
As investment firms that have a major influence in traditional asset markets have expanded their influence over digital currencies, their fluctuations now reverberated beyond the stock market and into the crypto country.
Established institutional investors tend to hold larger positions on the stock exchange. As volatility increases, they are sometimes hit by margin calls, brokers' requests for more cash deposits to cover potential losses.
In practice, this means that institutional investors may quickly be forced to liquidate positions elsewhere. Among other things, this can lead to Bitcoin being dropped.
These circumstances bring the two previously different areas more into harmony. It is a self-destructive cycle. The reason why professional investors like Bitcoin – a supposed lack of correlation to other assets like stocks – is justification for adding more portfolios, reducing independence from other assets.
The consequence of these stronger ties is paradoxical. It is as if collectors who value the value of treasure by its luster ruin relics simply by the frequency of their touch, smear surfaces and let objects lose their luster.
According to Ria Bhutoria, research director at Fidelity Digital Assets, Fidelity's two-year-old cryptocurrency company, this stronger correlation between digital assets and the stock market could only be temporary. "There are short periods of correlation during turbulence and uncertainty," she says. In the long run, she adds, there is reason to believe that, based on past experience, the correlation "could trend down over time".
Only time will tell how investors will treat Bitcoin if economic conditions deteriorate. The Fidelity team is closely monitoring what can happen, Bhutoria says in an "extended risk-off phase". This refers to a situation in which investors dump higher-risk assets such as high-yielding "junk" bonds and head for assets that are considered safer than US government bonds.
That said, will investors treat Bitcoin as a life jacket, a refuge to preserve people's prosperity, or will they treat it as flotsam?
Not everything that glitters is gold
The other two main reasons institutional investors said they liked digital assets were purely speculative.
Around a third of respondents to the Fidelity survey, which included interviews with 800 institutional investors from the United States and Europe between November and March, said they liked digital assets like Bitcoin because they viewed it as an "innovative technology game". Another third, 33%, said they liked it because it "has high upside potential".
These characteristics – a fancy technical aspect and the opportunity to get rich quickly – are contrary to the philosophy of the most famous value investors in the world. Warren Buffett, chief among them, compared Bitcoin to "rat poison squared".
An affinity for Bitcoin may be more suited to the mentality of high-risk venture capital investments. With central banks around the world introducing near zero and, in some cases, negative interest rates, many investors are looking for returns elsewhere, even with riskier assets like cryptocurrencies.
Some investors fear that a Fed looking to print money to avert financial disasters could lead to higher inflation. Some of these investors believe that bitcoin could serve as "digital gold" like real yellow stuff, a possible hedge against inflation.
Ironically, an asset with which so-called digital gold appeared to be least correlated in the first quarter was … gold. Another chart from Coin Metrics shows the increasingly unbound relationship between Bitcoin and gold in recent months.
The correlation between Bitcoin and gold has decreased in recent months. (Screenshot of the coin metric table)
While today's market conditions may be short-lived and abnormal, they question the beliefs of many professional investors and cryptocurrency creditors. At least today, people's most common assumptions seem to be against reality.
As the dust swirls in the rubble of the pandemic, investors may need to rethink what they find attractive about Bitcoin.
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