Crypto Prices Move in Tandem With Traditional Markets, Punishing Investors

The day of that record correlation, bitcoin dropped 10% and the Nasdaq Composite Index fell more than 4%, marking its steepest three-day point decline on record. Though bitcoin and other digital assets have long been viewed as among the riskiest investments in markets, analysts and portfolio managers say the depth of crypto declines this year and their tendency to echo other riskier assets such as stocks potentially could limit their adoption by mainstream investors. 

Crypto has “become part of the mainstream financial system, and that’s not good for its viability as an alternative asset class,” said

Richard Craib,

who runs a quant hedge fund in San Francisco called Numerai. “It’s not serving its original purpose as an uncorrelated asset.”

Last week, Mr. Craib sold $2.5 million of ether, his entire holding of the cryptocurrency, partly because ether has been trading too much like stocks and bonds. He first bought the cryptocurrency in 2014.

For several years, proponents of bitcoin, ether and other cryptocurrencies argued that they could serve as “alternative” investments that help offset losses in an investment portfolio, or at least cushion any declines in stocks and bonds. Those arguments, among others, helped persuade more hedge funds and other professional investors to add bitcoin and ether to their portfolios.  

Large funds, such as

Cathie Wood’s

ARK Investment Management LLC, and companies including

Elon Musk’s

Tesla Inc.

and

Michael Saylor’s

MicroStrategy Inc.

have purchased bitcoin, moves that have helped financial markets become more aligned with crypto markets. 

Meanwhile, crypto-related companies such as

Coinbase Global Inc.

have gone public over the past year or so, which has further connected digital trading markets with stocks and bonds.

But the 2022 market rout—which has spared little other than commodities whose value has surged at a time of high inflation—has stood that logic on its head. 

Traders and analysts say one reason markets are moving in tandem is because so many traditional investors have added digital currencies to their portfolios. As they have suffered from their stock and bond investments in the most recent market rout, some investors have been raising cash by selling crypto. At the same time, weakness in stocks and bonds has reduced the appetite many investors have for crypto.

 Last week,

Alesia Haas,

chief financial officer of crypto brokerage Coinbase, said: “Nasdaq is down, Bitcoin is down. And that has led to less and less dollars being put into crypto.”

Jeff Dorman, chief investment officer at Arca, a digital-asset investment firm that interacts with large institutions, said digital currencies’ 24-hour trading day makes it easy for hedge funds and other investors to place bearish trades as they turn pessimistic on the outlook for markets. He also said some funds have been selling digital assets because they don’t want to have to explain to more-conservative clients why they are holding these more speculative investments.

“They’re selling it to ‘window dress’ their funds,” he said.

Until recently, the institutions and other newer entrants were seen as beneficial to crypto markets. Now, as some of these same investors sell in a tumbling market, the downside to that shift is becoming more apparent, some say.

“Be careful what you wish for with regard to institutional adoption” of digital currencies, Mr. Dorman said.

Some say the recent moves downward in so many markets are a positive sign. Investors are coming to grips with a new world of higher interest rates, a realization that is necessary for financial markets to find their footing, these analysts say.

“When assets are sold across the board, it is a sign that a large cross set of the market understands there is a larger regime shift and valuation adjustment under way,” said

Michael O’Rourke,

chief market strategist at JonesTrading.

 “The market needs to get to a place of widespread acceptance that the ‘there is no alternative’ environment is over,” he said, referencing the common claim during the stock rally of recent years that low rates mean there was no alternative to investing in shares, crypto and other investments with risk.

Until recently, many mainstream analysts ignored the ups and downs of bitcoin, ether and other digital currencies, assuming they were mostly sideshows to the economy and mainstream financial markets. Now, some wonder if troubles in the crypto world might have some impact elsewhere, perhaps as plunging prices weigh on the spending of those who made big bets on the digital currencies or encourage some to trim stockholdings to offset crypto losses. 

Mr. O’Rourke argues that for now, stocks are driving cryptocurrencies, with little evidence crypto is having a wider impact on the economy or other markets.

Crypto bulls note that investments of all kinds usually exhibit closer correlations in bear markets, and that these trends usually don’t last long. 

Over time, Mr. Dorman predicts cryptocurrencies will return to being more uncorrelated to stocks and other investments, as new entrants enter the digital-asset market, including those that are more comfortable holding the assets during volatile markets. He notes that in the past, digital currencies were sometimes tightly correlated to gold, the Chinese yuan and even avocado prices.

“I believe we will eventually look back on the events of February and March 2022 as a turning point for the adoption of digital assets, and this short-term spike in correlation will just be a footnote as well, ” he says.

Write to Gregory Zuckerman at [email protected]