Crypto & Liquidity

Crypto, specifically Bitcoin, has consistently been a strong leading indicator of liquidity constraints. Bitcoin has had a 0.9 or greater correlation with global liquidity. What does this mean? First off, liquidity is a measure of the money supply or the number of dollars or other currencies floating around in the economy. When there are fewer dollars available in circulation, the price of Bitcoin tends to go down. This is also true for the S&P 500 and other investment assets, but to a slightly lesser degree. The S&P 500 is correlated at around 0.85. Still very correlated, but not quite as much as Bitcoin.

 

The other relevant consideration for Bitcoin is the magnitude of the movement. Since Bitcoin has been around, it has had a higher volatility than the S&P 500 with only a few exceptions for months or quarters. This means that Bitcoin’s price changes significantly with otherwise small shifts in liquidity. For example, in 2022 when we had rising interest rates from the Federal Reserve and an overall tightening of the money supply, we saw the S&P 500 drop 25% from its high. Bitcoin, on the other hand, saw a 67% drop from its high. This is representative of the higher volatility Bitcoin exhibits and Bitcoin’s higher correlation to liquidity.

 

As I write this, Bitcoin is currently trading near $80,000. It hit its all time high near the beginning of October less than 2 months ago when it was worth over $125,000. This means it has lost over 1/3 of its value in 6 weeks. This cannot be blamed entirely on liquidity issues because the global liquidity has not contracted that much since the beginning of October. Another driver of Bitcoin is the number of institutional buyers. Institutions have been large drivers of the price rise over the past year, but that appetite diminished as the price pushed over $120,000. Now that the price is hitting lows we haven’t seen since 2022, there may be more buyers looking for price stability and then jumping in at these attractive prices.

 

I don’t want to speculate on what liquidity will look like in the next 3 months, but the more the stock market and bond market are affected by tightened monetary policy, the more likely it is that the Fed or Congress will throw money at the problem and take it upon themselves to solve the problem. This isn’t the fiscally responsible thing to do, but those of us invested do appreciate a good market rally. Nothing gives you confidence like a bigger bank account!

 

The bond market has not been disrupted from this illiquidity, but it could be next. Maybe the long-term yields are being propped up already??? Why else have home loan rates not dropped when the Fed lowered interest rates?