In the past year, the correlation between the US stock market and the price of coins - bitcoin in particular - has strengthened to the point where any rise or fall in stocks is nearly always immediately reflected in the cryptocurrency markets. In this post, I'll examine this puzzling phenomenon, and will offer some thoughts as to when the correlation will finally break.
What stocks are
Stock confers ownership in a company. Most stocks allow shareholders to vote on the company's future direction, and an "average" person who owns a company's stock has just as much right to the profits of that company as does the CEO or founder who owns an equal number of shares. Many stocks pay out dividends, which are cash that the company has earned through its business activities. Thus, the foundation of a stock's value is how much money the company expects to earn in the coming years. Almost all stocks' prices are based upon investor perceptions of this value.
Even "meme stocks" are, to a large extent, priced based upon business performance. AMC, which skyrocketed in early 2021, actually has seen increasing ticket sales in its movie theaters recently. Of all the random stocks with similar levels of hedge fund speculation that could have been targeted by the meme traders, AMC ended up being the one that stuck in part because the movie theater business had some potential for a turnaround.
Stocks are like purchasing a contract. In exchange for that purchase, there is a specific promise made to share ownership and profits of the company.
What coins are
Most coins (and even most NFTs as currently implemented) are not like stocks. They represent numbers on a blockchain and do not confer actual ownership in anything. When I purchase a coin or an NFT clip of an NBA play, the only right I gain is to later change the blockchain. Without possessing coins, I can't make any changes on the coin's blockchain (note: not only does "owning" an NFT not provide copyright, "owning" one isn't even sufficient to assign to another person without owning another coin too.) People's interpretation of what the current state of the blockchain means is what provides value in coins.
What I can do with coins is only a small subset of what I can do with stocks. While I can lend and borrow both stocks and coins, bitcoin doesn't pay any dividends, and even if you owned 51% of all the bitcoins in existence, you would still not have the power to unilaterally change the rules of how the blockchain operates. Dollars themselves are similar; while owning a lot of dollars or bitcoins can influence people politically, owning a lot of dollars does not grant the power to unilaterally change how many dollars are printed or how they can be spent.
One can argue over whether bitcoins are an "inflation hedge" or "digital gold" or any of the other buzzwords that often get thrown around in the mainstream media, and those topics are indeed a subject for another article. What doesn't make much sense is to take a position that bitcoin, ethereum, and dogecoins are "tech stocks," because they lack most of the properties of stocks.
Trading coins based on world events
For now, it doesn't matter whether coins are actually stocks or not. Since many people are buying and selling them as if they were, trading strategies based upon the wider stock market are likely to be successful. As I pointed out in the the previous post and its replies, at this time world events like how widely monkeypox spreads, how the war in Ukraine proceeds, and what the Fed does are more important in determining the direction of the cryptocurrency markets than are advances like the Mimblewimble protocol on litecoin, which is actually a significant improvement to the coin.
You won't hear this position taken very often, because many Discord channels and reddit subreddits use "off-topic" rules as an excuse to censor negative outlooks on cryptocurrencies. It is critical, for the foreseeable future, to avoid reliance on discussion forums about cryptocurrencies to get information about market moves, because many forums are silently deleting the most important information. Right now, coin "fundamentals" do not matter.
"Decoupling" from the stock market
At some time in the future, cryptocurrencies will "decouple" from the stock market. The decoupling is going to take a lot of people by surprise. One day, the stock market will continue to crash, and cryptocurrencies will rise, and people will wonder why that happened.
The reason why is simple: bitcoin never was a stock, as indicated above. When many participants in a market are under an erroneous belief, that market is teetering for a collapse. I listed some examples of such beliefs previously, such as the idea that one can create economic value by playing a game. The entire correlation of how the market moves right now is one of those erroneous beliefs.
The timing of when the erroneous belief collapses is more complicated to predict. Right now, the coin markets consist of multiple groups of people: those who spend cryptocurrencies on goods and services, those who hold cryptocurrencies because they see them as stores of value, people who need them to perform financial transactions, such as spending ETH on gas costs, people who buy and sell coins to hold those which provide innovative features, and so on.
There also exists a group of people who purchase cryptocurrencies who don't actually understand how blockchains work. Hearing that someone is going to make an "investment" in cryptocurrencies is a clue that person may be one of this type. This type of person responds to the ads on CNBC from funds that try to convince people to "invest" in bitcoin; you will hear this terminology over and over. Many of these people have never actually used any coin at all. They don't know how mining works, they don't understand ideas like inputs, outputs, and transaction fees, and they don't bother to learn even basic concepts of computer science that can explain how they are allocating their money.
The key difference between these "investors" and the other groups is that the investors rely on secondary information, while the investors rely on primary sources. It's the difference between being concerned about the financial impact of monkeypox from reading an article about it on CNN, rather than actually visiting the forums where people are discussing the types and meaning of sequencing errors from the different platforms. Or, it's like deciding that the Fed would raise interest rates because CNBC said so instead of actually reading the text of the Fed mining minutes. Or, it's like scrolling through twitter posts about Ukraine instead of the Institute of the Study of War's daily analysis of the battlefield. All of the secondary sources summarize only a cursory, often sensational, version of the facts, and more importantly, omit key concepts that one needs to understand likely outcomes.
Conclusion
If the price of bitcoins were increasing during this period of high stock correlation, then the number of "investors" who believe that coins will mirror stocks would increase, and the correlation would continue to grow stronger into the future. In this case, the proportion of people who believe coins are stock would grow compared to the other groups.
However, there currently is a bear market, and prices are falling. As a result, "investors" continue to get flushed out as they sell in tandem with the stock market's crashes. Meanwhile, the other groups continue to both buy and sell, meaning that the proportion of these other owners compared to the "investors" increases. At some point, enough people who believe that coins are stocks will have sold out. At that time, the coin markets will begin reacting independently of the stock market, because everyone who was acting on the stock market's movements no longer will own any coins to sell.
I've already stated that there needs to be one more washout before a trend reversal due to the excess of bad applications in the cryptocurrency industry. There is also an all-time record of long positions in bitcoin right now. Whenever the next leg down in the stock market begins, the investors will panic, causing these longs to begin a liquidation cascade, flushing out the remaining investors and creating a major reset in the coin markets.
After that reset, I expect the correlation between bitcoins and stocks to be eliminated. Then, people who exchange dollars for bitcoins will be doing so based on a different belief - that there is no correlation between the two - further reducing the proportion of the erroneous "investor" class and cementing the correct belief that coins are a completely different asset class than stocks are.
Bitcoin is not a stock
Written by: Steve Sokolowski
Steve Sokolowski Author
Steve Sokolowski is a longtime miner, cryptocurrency believer, interest platform depositor, and PROHASHING owner. He can be contacted at help@prohashing.com.
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