Bitcoin and the Equity Markets were crushed yesterday, which leaves one wondering…
Why Does Bitcoin Follow Market Sell Offs?
Economists and asset managers assert that the recent market drop is tied to debt pressures facing Evergrande, a Chinese real estate company about to default on $300 billion dollars in debt. The markets sold off fearing that the Evergrande’s default may have systemic aftershocks, in a similar way that Greece did back in 2010.
To many investors new to Bitcoin, yesterday’s drop may come as a surprise. Much of the narrative surrounding Bitcoin has been centered around it being a store of value and an inflationary hedge against bailouts and money printing. This seems counterintuitive to Bitcoin’s drop-off since it may take a bailout to save Evergrande (and avoid potential global economic aftershocks).
Having invested in Bitcoin since 2017, there are some key underlying qualities that are not immediately apparent to many investors, which makes Bitcoin unique and sometimes difficult to understand (especially to those who only see it as a store-of-value or a safe-haven asset).
Safe-haven assets are thought to fare well during times of crisis (as people pile money into them when they are uncertain or afraid of what’s to come). Gold filled those weary shoes yesterday by remaining relatively stable as the markets sold off. But Bitcoin, on the other hand, went down with the rest of the market dropping from $47,000 to near $40,000.
If Bitcoin is a store of value, shouldn’t it react to market sell off like gold?
Bitcoin does indeed share similar qualities to gold, in that they both have a limited supply (there will only be 21 million Bitcoin ever produced); and they both run counter to money-printed fiat, which is manipulated by way of fiscal stimulus and the collective monetary policies of sovereign nations with their own currencies.
But unlike fiat, Bitcoin’s monetary policy is built into its protocol; the amount of Bitcoin generated through mining is a preset condition that cannot be changed without the consensus from the entire community (which is a large, democratic community; it would take a hard fork to drastically change the protocol… this is an extremely unlikely scenario).
However, unlike traditional stores of value, Bitcoin is also a revolutionary technology that allows for peer-to-peer transactions and may even become the base layer of the entire internet. In this regard, Bitcoin is much like a speculative tech stock where investors are willing to pay a high premium for the asset, and thus speculate on its future success.
This doesn’t mean that Bitcoin doesn’t have gold-like tendencies that run counter to inflation caused by money printing. Afterall, its creator, Satoshi Nakamoto, intended for
Bitcoin to be an escape from the risks inherent within fiat currencies… such as the bail out of big banks to avoid a financial meltdown in 2008 (as Satoshi’s text in the genesis block on the left is often referenced).
This relationship between money printing and Bitcoin is best seen below. Around January of 2018, Bitcoin’s uptrend came to a dead halt. This coincided with the Federal Reserve’s intensification of money supply tightening (which is an increase in interest rates to avoid inflation). The downward pricing pressure on Bitcoin continued up until March of 2020, when Fed reduced rates and the US government doled out stimulus to everyone to keep the economy afloat… at which point Bitcoin skyrocketed with the change in policy.
Bitcoin may not have a long enough history and maturity to fully evaluate the accuracy of these trends. The most recent Bitcoin cycle also happened right around the time of the last halving, where the Bitcoin reward to miners is cut in half. This reduces the Bitcoin supply, which in turn puts upward pressure on the Bitcoin price.
There is no doubt that the Bitcoin stock to flow model (chart below), which is based on the halving as described above, has had a major impact on Bitcoin’s price. Yet since the Federal Reserve also appears to impact the price of Bitcoin, it is difficult to extract if the stock to flow model (below) is the only factor. There may be a Bitcoin Fed-to-Flow Model at work as well.
Stock-to-Flow Model Source: Plan B
As we begin to approach a Fed tightening phase due to inflationary pressures, it will be interesting to see if Bitcoin can maintain the Stock-to-Flow model. As you see in the chart, we have been trading below the mean forecast since Bitcoin’s April highs.
I believe that the overall determining factors driving the price of Bitcoin are primarily: a) major technology platform with use cases far beyond just digital currency, b) an asset with increasing scarcity based on the stock-to-flow model, and lastly, c) an asset impacted by US and global monetary policy alike, i.e, money printing.
To summarize the answer to the question:Why Does Bitcoin Follow Market Sell Offs?
Bitcoin’s primary function is in being an absolute peer-to-peer, technological behemoth, it makes sense as to why Bitcoin would sell off too when the markets are “risk-off”. And as explained above, being a productivity enhancing technology does not depreciate its value as a long-term inflationary hedge.
From a hodlers’ perspective, this is exactly why I love Bitcoin. Yes, there is extreme volatility, as is often the case with any disruptive technology rapidly increasing in adoption, but you also get a long-term defensive hedge against global non-stop money printing. Thus, in essence, Bitcoin is inflationary resistant innovation.
But please be advised: I only write this to share my own beliefs, and the research I’ve discovered in no way should be considered investment advice. I am also a huge believer in the decentralized, socioeconomic impacts of Bitcoin… so this theme goes beyond just accumulating wealth for me. Despite this very bullish thesis, it is important to know that Bitcoin is volatile, and it’s not without risk. Thus, always do your own research when determining if an asset is right for you or your family.