Boston - In recent weeks, we have witnessed a substantial sell-off and partial recovery in Bitcoin and other cryptocurrencies, in the wake of negative comments from Elon Musk and moves by Chinese authorities to clamp down on Bitcoin mining. As a relatively new asset class, cryptocurrency is hardly unusual in exhibiting such volatility, even if the approximately 30% one-day drop in Bitcoin on May 18 was probably more than many crypto observers would have thought likely.
More interesting, from my perspective, were the signs — albeit modest ones — of an emerging link between crypto and the broader financial markets. For one, the three-day slide of the S&P 500 Index beginning on May 10 — in which this benchmark for U.S. stock market performance gave up 4% — coincided with the start of Bitcoin's big sell-off on May 10.
Bitcoin sold off sharply in May, as did other cryptocurrencies
Source: Bitcoin USD data provided by CoinMarketCap as of 05/26/2021.
Also during some days in late May, intra-day trading between the S&P 500 and Bitcoin (and Ethereum as well) was very heavily correlated. Typically, crypto led the price movement, and broader asset classes moved in the same direction. The beta — or incremental move of Bitcoin per tick of the S&P 500 — was not as large as anticipated, but notable nevertheless. Recall that just a few years ago, around 2017, Bitcoin sold off following a substantial rise, but there was no impact on broader financial markets.
Broader crypto acceptance
What has changed? Clearly, today's highly unusual macro environment is playing a role. The world is awash in liquidity, thanks in large part to dovish central bank policies, and the dollar has been starting to weaken — factors that have helped drive all risky asset prices higher. The crypto sector has been bid up to a greater extent than most.
Just as importantly, we are beginning to see a handful of traditional market players test the water, including investment banks, hedge funds, corporate treasuries (like Tesla's) and family offices, who mostly gain exposure through venture capital or crypto hybrid funds. But the market is still mostly dominated by a relatively small universe of devoted investors heavily weighted to the sector.
When institutional crypto positions become the norm, rather than the exception, the potential spillover from crypto crash contagion and bull runs is likely to be a lot larger. We're not quite there yet. Indeed, the recent crash may have taken some of the wind out of crypto's sails, possibly slowing the process of broader integration — though the market has been bounced back sharply this week.
But I think the trend towards "mainstreaming" crypto is bound to continue — especially when there are ETFs, established on-ramps for investing in Bitcoin and Ethereum by private wealth and wealth management, and observable and verifiable track records for crypto assets.
Bottom line: As the worlds of traditional finance and crypto collide, all market participants and policymakers may be wise to follow the digital money. We expect to see correlations between crypto and broader financial markets increase.