What’s Driving the Price of Tomorrow’s Digital Assets | Is the Stock Market Tied In To Crypto?

You might be surprised to find out what drives prices in cryptocurrency is the same as what drives prices in other investments. With all the upset in the crypto world about stablecoins, it’s easy to overlook some factors.

What Drives Price

A top economist at the Coinbase Institute is revealing one factor that will likely determine the future prices of crypto assets.

Cesare Fracassi, the chief economist of Coinbase’s research arm, says shifting attitudes toward future crypto market expectations could drive up the prices of digital assets.

“The most important pillar of the market efficiency hypothesis is that any traded asset, from stocks to bonds, commodities, and even crypto, incorporates into its price the market’s expectation about the future value of the asset…

Thus, according to the market-efficiency view of crypto markets, only changes in the outlook of the crypto industry relative to what is already expected will bring changes to prices.”

Fracassi says the three-digit returns crypto assets have generated over the past few years indicate the industry’s future outlook has improved.

“From June 2017 to June 2022, [the] crypto market cap rose 860%, indicating that the outlook about cryptocurrencies today is much brighter than it was back then:

The adoption by institutional and retail investors and the laying of the foundations of Web 3.0 (i.e., decentralized finance applications, non-fungible tokens (NFTs), decentralized identity solutions, tokenization of real assets, and decentralized autonomous organizations) were part of the reason for these exceptional returns.”

Fracassi further says the market sees digital assets becoming more correlated with traditional assets.

“Since 2020, the correlation between the stock and crypto asset prices has risen significantly: while for the first decade of its existence, Bitcoin returns were on average uncorrelated with the performance of the stock market, the relationship increased quickly since the COVID pandemic started.

This suggests that the market expects crypto assets to become more and more intertwined with the rest of the financial system, and thus to be exposed to the same macroeconomic forces that move the world economy.”

The Stock Market Connection?

The two markets are not identical in momentum of course, but the affect one has the other cannot be denied. This from Investopedia.

Cryptocurrency Prices vs. Stock Prices

Interest in Bitcoin and cryptocurrencies as an investment asset class emerged sometime around late 2016, as witnessed by the slow, steady price increases through that year into 2017 when Bitcoin’s price crossed $1,000. Media outlets covered the phenomenon, and prices climbed throughout the year to peak at nearly $17,000 before settling down to fluctuate between $3,000 and $10,000.4 The Covid-19 pandemic in 2020 created a significant worry for investors, who panicked because businesses and economies were slowing and shutting down.

During the pandemic, the S&P 500—the stock index used most by investors to gauge the market—lost more than 110 points as investors transferred their assets to alternative investments.1 The U.S. economy floundered into a short recession, then began a recovery in which stock prices climbed to more than double their value at the end of the recession.

By the time the index and economy had recovered to pre-pandemic levels, investors were convinced that Bitcoin was a new asset class that could be used to realize returns under some of the most austere market conditions. Many corporations had already begun to sink money into cryptocurrency, and Bitcoin’s performance during the pandemic reinforced their positions and outlooks. Bitcoin had made its investing debut and attracted a large following of retail investors, institutions, and enterprises.

Bitcoin, which had been traded like a stock for several years on cryptocurrency exchanges by early adopters, began to be treated like a stock by traders and investors—solidifying its position as an asset class.

Crypto Price Correlation

As Bitcoin morphed into an asset class, more interest was created. Brokerages and institutions gained traction with regulators and offered investment opportunities like Bitcoin-linked ETFs and 401(k)s that allowed investors to place Bitcoin in them.56 Because institutions were providing familiar instruments, investors appeared to become more comfortable with cryptocurrencies.

In late 2021 and into mid-2022, cryptocurrency prices rose and fell similarly to equity prices. The chart below shows Bitcoin’s (BTC) price compared to the S&P 500 (SPX) and the Nasdaq 100 (NDX). It’s important to note that the graphs overlay each other for comparison—Bitcoin’s price was much higher than it appears on the chart.

SPX is a measurement of the performance of large-cap stocks. NDX measures the performance of 100 of the largest non-financial companies listed on the exchange; most of them are involved in technology. The graph shows SPX, NDX, and BTC price history from November 2021 to May 2022. You can see prices of each rising and falling with each other—although Bitcoin demonstrates much more volatility—suggesting that Bitcoin is viewed and treated very much like a stock by traders and investors.

The cryptocurrency price correlation that has emerged appears not to be that Bitcoin is related to equities in any way but instead that investors and traders are inadvertently creating a correlation. They are trading Bitcoin the only way they know how—the same way the asset classes they are most familiar with are traded.

What Does It Mean for Investors?

Cryptocurrency’s price correlation with equity could be a coincidence or indicate that cryptocurrency prices are indeed following trends in equity prices. So, what does this mean for investors?

It is possible that because investors appear to be treating cryptocurrency like stocks, digital assets can react to market influencers just like equities do. For example, on May 4, 2022, the Federal Reserve announced that it was increasing its target federal funds range to .75%–1%.7 On May 5, 2022, Bitcoin fell to around $3,100.4 NDX lost about 1,400 points, and SPX lost about 150 points.18 The cryptocurrency price was much more pronounced, but the effect was the same.

It is also likely that investors, as a whole, are treating cryptocurrency the way they treat equities temporarily. Cryptocurrencies are still in their price discovery phase, where the market is determining the role they will play. When they were first introduced, investors paid them no attention.

Once it was noticed that you could purchase a bitcoin, hold it, then sell it for more, investors became interested. There was no market experience with digital assets, so prices fluctuated wildly as the market began experimenting and speculating.

What this means is that investors should approach cryptocurrency cautiously. It is difficult to tell how the market and prices will act in the future. Bitcoin and other cryptocurrencies could remain correlated to equities, or they might not. If you’re interested in investing in cryptocurrencies, it’s best to talk to a professional financial advisor familiar with them. They can help you determine what is best for your financial circumstances and investing goals.