What Does Bitcoin's Decoupling From Stocks Mean For Crypto?

The decoupling of Bitcoin and stocks could resurrect one of the long-held promises of cryptocurrencies, namely that they can serve as a hedge to protect investment portfolios when equities sell-off during times of instability, as their proponents have long said.

What Does Bitcoin's Decoupling From Stocks Mean For Crypto?
What Does Bitcoin's Decoupling From Stocks Mean For Crypto?

Whenever traditional investors believe they have a firm grasp on the significance of cryptocurrencies in financial markets, the digital asset class always seems to prove them incorrect. In September, the ink on research pointing me that Bitcoin and stocks were moving in the same direction (downward) had hardly dry when the favourable connection abruptly reversed this month. As it stands now, the S&P 500 is down about five per cent from its last record on Sept. 2, while the biggest cryptocurrency is up 10 per cent.

The decoupling of Bitcoin and stocks could resurrect one of the long-held promises of cryptocurrencies, namely that they can act as a hedge to safeguard investment portfolios when equities fall off during times of instability, as their proponents have long said. That's a function that's in great demand right now, with many people concerned that Treasuries won't be able to fill it during a period of ultra-low returns and rising inflation.

Despite this, many people are wary of attempting to shoehorn crypto into solid relationships with traditional assets because of its highly speculative character and frequently inexplicable volatility. 
It's a matter of understanding which type of "trading window" is dominating sentiment, according to Stephane Ouellette, CEO of crypto-focused platform FRNT Financial Inc. These are often fast-moving targets. 

"Sometimes it's connected with more speculative equities like tech, other times a store-of-value attitude takes over and it's correlated with gold; in significant liquidations the space tends to correlate with risk assets in general," he explained. "While for periods these relationships are relatively consistent, they tend to change at a moment's notice. And that appears to have happened here."

"We appear back in some type of inflation-hedge, hard-asset-correlated window" now that it's unlinked from stocks, he said. That aligns with JPMorgan Chase & Co. strategists like Nikolaos Panigirtzoglou, who hypothesised in a note Wednesday that institutional investors may be returning to Bitcoin as a better inflation hedge than gold. 

Platinum, a traditional inflation hedge, has been the most closely linked macro asset to Bitcoin among those tracked by Bloomberg over the last 10 trading sessions, with a correlation coefficient of 0.76. (A coefficient of 1 means the assets are moving in lockstep, while minus-1 would show they're moving in opposite directions.) However, the mercurial nature of crypto and the shifting narratives employed to explain its performance, raise the risk that investors could be fooled by randomness.

It's probably too early to get comfortable connecting dots between crypto and traditional asset classes, according to Brian Mosoff, CEO of Toronto-based investment company Ether Capital Corp. He sees crypto as still very much a risk-on asset like stocks because investors who have bought over the past year or so "don't yet have full conviction that the asset class is here to stay."

Mosoff, on the other hand, views crypto's potential as an uncorrelated asset and hence a helpful hedge in the long run. That may be part of what's driving Bitcoin's recent rally, as concern grows over the consequences of the United States' debt ceiling brinkmanship and Federal Reserve policy. While politicians can push the government to default on its debt and central bankers can increase or decrease the amount of money in circulation, the supply of Bitcoin is restricted and predictable due to its software code. 

"This is a moment when the new world steps in and says there's a reason why these are core functions and core value propositions to the design of this asset class," he said. "Investors are slowly saying maybe it's not such a crazy idea and that's why capital is trickling into this space," he said. Of course, there are potential reasons for crypto's recent bust and boom that have nothing to do with its theoretical or real role in investment portfolios.

More bullish news has overshadowed China's current restriction on cryptocurrency transactions, which sparked a selloff last month: The asset class is too enormous for investors to ignore, according to a Bank of America deep-dive research report, U.S. Bancorp's launch of custody services for institutional investors, and news that Brazil is exploring legislation making Bitcoin legal cash (the reality is that there is a proposal to regulate cryptocurrencies). 

Furthermore, according to CoinDesk, there have been some positive statements about crypto from US lawmakers, as well as hints of big-money investors, or "whales," making substantial purchases. Another clear explanation for Bitcoin's decoupling from stocks this month is that it's being pumped like crazy. On social media, the term "Uptober" has swiftly spread among committed believers as a rallying cry for wins in October. 

The new rise, according to Interactive Brokers' senior strategist Steve Sosnick, is reminiscent of the speculative frenzy surrounding meme stocks like GameStop Corp. and AMC Entertainment Holdings Inc., which were propelled by intensive social-media campaigns. "I believe they draw from a similar, if not the same, pool of investors," he said. "I believe that the psychology that underpins trading is comparable."