Some say that cryptocurrency and stock markets are tightly interconnected, weaving the common fabric of the present-day global financial system. Their opponents believe those are two completely separate financial entities with different regulation (which is true) and, most importantly, different set of investors (which still needs to be proven). In this article we will take a closer look at the processes of money transfer between the equity market and the cryptocurrency one. In the end we will also see if there is a viable connection between the two markets.
Let’s start with a traditional view on relations between equity and cryptocurrencies. According to the table above, the correlation between S&P 500 — a stock market index that follows top-500 American corporations — and all major cryptocurrencies is weak, yet still positive, ranging between 0.07 and 0.23. Certain experts have stated that the two markets are, in fact, much closer to each other than previously thought. They cite the most recent crypto plunge and link it to the depreciation of S&P 500, Dow Jones and NASDAQ. This group of people believes that the downfall of America’s most important indices coincided magically with a dip in the cryptocurrency market. Their initial recovery phases fall within the same timeframe, too.
This theory is far for perfect and here is why. The cryptocurrency market began to contract on January 7th, much earlier than the stock market. The latter first demonstrated short yet steady depreciation on January 26th, which lasted for only ten days. Between January 26th and February 5th, the crypto industry has lost almost 3a0% of its value, while S&P 500 “only” depreciated 8%. More than that, in a 30-day period between January 7th and February 6th the cryptocurrency market has lost 66% of its value. Depreciation of a comparable scale would have no doubt annihilated the national economy of the United States and trigger an international crisis of unimaginable proportions. This is why it is safe to assume that two events — depreciation of the stock market and a sudden dip in the crypto industry — have little in common.
As a trader you would probably want to know if money, that left the cryptocurrency market during the recession, have entered the equity market, and vice versa. There is no way to accurately track all money movements across the markets. However, certain assumptions still can be made.
Trading volume of the world’s most popular cryptocurrencies influence the direction of the dominant trend. If both the volume and the asset prices go up, then somebody is actively buying cryptocurrencies. If the volume goes up but the prices keep falling, then traders are selling their assets. During the most recent crypto downturn trading volumes have contracted almost 50% with only four noticeable exceptions. The contraction of the trading volume can hint at the dominance of holders, people who stick to their assets and avoid panic selling them during the bearish market cycle. S&P 500 trading volumes remained relatively unchanged during the correction and went up slightly once the recovery was imminent. By comparing trading volumes, we can state that money, that left the cryptocurrency market, didn’t make their way to the equity market. Moreover, if the above-mentioned situation happens, it will create extensive buying pressure, pushing S&P 500 and other indices higher, not lower.
Whatever the reason for coordinated moves in the markets, the correlation does not imply causation. Currently there is no reason to believe that one market (be it equity or cryptocurrency) can directly and effectively influence the other.
As seen from the analysis provided, depreciation and appreciation of the cryptocurrency on one hand and conventional assets on the other have little in common. Their movements are, most certainly, powered by two completely different groups of people. Again, conservative investors have expressed their doubt in bitcoin and altcoins, citing their volatility and sticking to well-known trading strategies. Crypto enthusiasts, people who believe in long-term success of cryptocurrencies in general, see no need to invest conservatively, as they can increase their investments manifold during an extremely short period of time.
Cryptocurrency and equity markets can, however, become more tightly interconnected in the future, when, or better yet, if cryptocurrencies make their way to the list of generally accepted investment instruments.
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