Bitcoin’s Correlation with Tech Stocks
On the evening of Friday, December 3rd, Bitcoin suffered a flash crash of over 20%: going from $53K to $42K. This move could have been expected given that earlier that day, the tech-heavy NASDAQ stock index closed 348 points down (a decrease of 2%) as investors digested the Federal Reserve’s announcement of the tapering of “easy money” policies in order to fight rising inflation.
Despite true believers’ description of Bitcoin as “digital gold,” the number 1 cryptocurrency has not behaved like an uncorrelated asset and instead has been strongly positively correlated with the stock market for many years. The 20-week correlation coefficient between Bitcoin and the NASDAQ index has hovered between 0.5 and 0.8 for much of 2020 and 2021. (A correlation coefficient of 1 represents perfect positive correlation, while a coefficient of -1 represents perfectly inverse correlation).
Compare this to the correlation between gold and the NASDAQ, which has historically been much less consistent and often inversely correlated.
Further analysis shows that while crypto is indeed correlated with technology stocks represented in the NASDAQ index, this relationship is not perfect as dips in correlation in late 2019 and mid 2021 have proven. This means that from a portfolio management perspective, Bitcoin may not serve as a better hedge against market risk as traditional gold.
Of course, no analysis of Bitcoin prices can be complete without acknowledging Bitcoin’s significant outperformance compared to any other asset class: in the year 2021 Bitcoin is up 65% while the NASDAQ is up 21%. But perhaps it’s time to stop calling Bitcoin “digital gold” and give it credit for being a high-risk and high-reward asset with features that go beyond that of precious metals: it’s the only true scarce resource in the universe, it has the potential for smart contract applications, and it has a first mover advantage as the first in a novel asset class (cryptocurrencies).
First, Bitcoin is the one true scarce resource in the universe because it’s limited by a collective social agreement. Gold could always be mined from asteroids or created via nuclear fusion reactors, and land can even be reclaimed from the sea or developed in space, but so long as the participants of the Bitcoin network agree on the limit of Bitcoin, there will only ever be 21 million Bitcoin in the universe, with over 20% being lost in unused or locked wallets.
Second, Bitcoin has uses beyond a store of value as upcoming upgrades to the source code, mainly the Bitcoin Taproot upgrade, which provides new features including more complex smart contracts. Smart contracts are decentralized programs that run on a blockchain: NFTs and many DeFi and GameFi projects exist as smart contracts. With the upcoming Taproot upgrade, smart contracts on Bitcoin’s blockchain can be more complex and cheaper to execute, narrowing the capability gap between Bitcoin and “gen 2” cryptos like Ethereum and Solana.
Third, Bitcoin is and will always be the first cryptocurrency, and it’s first-mover advantage cannot be understated. The effects of first mover advantage can be clearly seen in Google’s worldwide search trends over the last 12 months, which clearly shows “Bitcoin” outpacing searches for “Ethereum” and even “cryptocurrency” by many orders of magnitude. For many people, Bitcoin IS cryptocurrency. These network effects translate to more market acceptance, a more resilient and distributed mining network, and other positive network effects such as regulatory acceptance.
The behavior of Bitcoin’s price shows the fundamental limitations of using the analogy of “digital gold” to describe the first of a novel asset class, and if Bitcoin is to reach the mainstream adoption that its supporters want, they will need to stop comparing Bitcoin to gold and admit that it’s something different and in many ways, better than the shiny yellow metal.
