Cryptocurrencies

How Will a Stock Market Crash Influence Bitcoin?

How Will a Stock Market Crash Influence Bitcoin
Written by Louise Vee

Thinking About Bitcoin’s Changing Role As A Hedge Against Collapse

Recently, Bitcoin and all the other cryptocurrencies have been attracting a lot of attention. More specifically, they have started to attract the notice of institutional investors who have lots of cash and see limited opportunity in elevated stocks and a tanking bond market. With these factors in mind, they have been buying up ever-growing quantities of cryptocurrencies both as a speculative investment and as a hedge against broader market downturns.

This raises the question as to how much utility there is in using Bitcoin as a hedge against market turbulence. While it might seem, at first glance, to be extremely counter-cyclical, there are reasons to suspect that this may not be correct in the event of a major downward move. It may also depend on what sort of decline is under discussion and how deep and protracted it may be.

First Off, What Happened in the Previous Correction?

As we see from the two charts below, when stocks were dumped in March of 2020, Bitcoin got dumped as well.How Will a Stock Market Crash Influence Bitcoin

How Will a Stock Market Crash Influence Bitcoin Dow 30

Are We In the Midst of an Asset Bubble?

With interest rates approaching 0%, investors have been able to borrow bundles of dollars. The result has been that much of that capital has gone into investments like tech stocks, commodities and cryptocurrencies. In a world where low interest discourage savings, governments are encouraging people to borrow and spend. In an effort to generate returns, investors have thrown cheap cash at various assets which has led to the a massive inflation in these instruments. Tesla for example is at a PE ratio of more than a 1000 in early 2021.

Should interest rates start to rise, the purchasing power of overindebted investors with home loans and other debts will suddenly disappear. Cheap money that were pushed into many investment classes will be withdrawn to service debt.

Eventually it will lead to the decline of assets back to more traditional price earnings valuations and lead to major players getting out of the markets early and parking their surplus funds elsewhere until the shakeout is complete. In a world where Bitcoin is gaining more of a safe haven reputation versus printed Fiat currencies, we cannot predict if BTC would attract more of the flowback and recover faster.

Bad News Drop

A bad news drop might be triggered by something such as a renewed pandemic, some terrorist event that causes serious damage, or some form of natural disaster that takes out part of the logistics chain of the world. So far as Bitcoin is concerned, the worst possible risk for it happens in a crisis severe and sharp enough to wreak havoc in the hedge funds and among speculators in general. Margin calls would be made and have to be met by selling the most liquid assets on hand in order to raise fast cash.

Bitcoin would certainly be one of those assets that would get hastily dumped. This would quite obviously drive its price down in tandem with the wreckage inflicted on the rest of the market. The price might go lower still if some black swan events crop up simultaneously.

There have been numerous cases where allegedly theft-proof cryptocurrencies have disappeared from custodial accounts. Uncovering a new case of vanishing Bitcoin at the same time that a rush is on to covert it into cash in order to cover market calls would create a pretty good-sized snowball on top of a mountain.

Ultimately, while Bitcoin is often regarded as a hedge against market turmoil, it is certainly possible for it to get whipsawed itself as a result of such activity. It is also important to note that Bitcoin is just as dependent as any other modern asset class on the survival and effective functioning of the overall infrastructure of civilization in order to remain valid.

Final Thought

Bitcoin is becoming increasingly financialized as it gains widespread acceptance in the investment community. There are cryptocurrency ETFs. There are cryptocurrency futures and options trading. What this means going forward is that the behavior of Bitcoin in a crisis is likely to be different now than it was previously.

It is no longer an untethered asset. Instead, it is now in a place where the same people who dominate and move other markets are starting to gain the same hold over Bitcoin’s movements. The big question is whether it is sufficiently controllable by large powerhouse players or if the wider vox populi still reigns over its fortunes.

Cover Image

Image by Mediamodifier from Pixabay

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Louise Vee
Tech Geek and Traveler by heart. Loves Wildlife, Nature and Street photography. Cancer survivor.

About the author

Louise Vee

Tech Geek and Traveler by heart. Loves Wildlife, Nature and Street photography. Cancer survivor.

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