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Beware: Bitcoin Might Blindly Chase the Dow into the Next Financial Crisis

Last Updated March 4, 2021 2:44 PM
Gerelyn Terzo
Last Updated March 4, 2021 2:44 PM

Be careful what you wish for. The crypto community continues to beg big investors to get on board with bitcoin, but there could be some unintended – and alarming – side effects. Most notably, bitcoin could be destined to hitch its wagon to the fate of the Dow Jones Industrial Average.

While cryptocurrencies should be a respite from the stock market, their mettle has yet to be tested in the flames of an economic downturn. Plus, as widely cited economist Alex Kruger points out, crypto has thus far only been a retail phenomenon. Once the institutional doors swing open to crypto, the dynamics could shift. In times of trouble, investors just may find that bitcoin and the Dow have more in common than they previously thought – despite the decentralized nature of crypto.

bitcoin price vs dow jones djia
If Wall Street goes full-crypto, the bitcoin price could become highly-correlated with the Dow – for better or worse. | Source: Yahoo Finance

Kruger might have shocked some in the crypto community when he suggested that in time of economic crisis, bitcoin will offer little flight to safety.

“IMO crypto will behave like a highly correlated high-beta asset class. Not where you go to for diversification purposes.”

Bitcoin and the Dow – Kissing Cousins in the Next Recession?

What gives? Bitcoin and the Dow are supposed to be non-correlated assets, not trade in lockstep when investors need diversity the most. Crypto should provide the shade of diversification that bolsters returns and slashes risk. That’s what “asset allocators” are banking on. Bitcoin’s low correlation with the Dow, however, could be shortlived.

Wall Street Wields a Double-Edged Sword

Institutional capital has often been lauded as the panacea to crypto’s woes. A bitcoin ETF, for example, will open the floodgates to pensions, endowments, and family offices. Big investors could be a double-edged sword, however, one that exposes bitcoin’s true identity as another Dow in disguise during the next economic recession.

“However, crypto is a nascent asset class. Not a mature one. Correlations should change as the asset class matures and institutional players slowly enter the space. And correlations RISE during crises.”

With a potential recession looming over the economy, investors could find out sooner than later just how uncorrelated bitcoin is from the Dow.

Vinny Lingham on Bitcoin and Altcoin Decoupling

Another matter that is near and dear to the heart of investors is bitcoin’s correlation within the crypto sphere. Not only might bitcoin eventually be correlated to the Dow, but it is driving the performance of altcoins here and now.

Vinny Lingham, a cryptocurrency pioneer who runs blockchain ID platform Civic and increasingly sounds like a perma-bear, isn’t convinced the crypto winter is over. He suggests it’s only when bitcoin eventually “decouples” from the broader crypto market that a bull market will be sustainable.

Lingham is focused on data points such as bitcoin’s dominance, which currently hovers below 51%. He says:

“It’s easy to argue that bitcoin can be worth $10k or $20k, or even $100k. But the problem is that as the price has been rising toward those levels, we’re not seeing bitcoin dominance increase disproportionately.”

In the interim, altcoin prices are rising purely on sentiment and not fundamentals, which he suggests “makes no sense.”

One thing is clear from all of this commentary. For an emerging investment category, bitcoin’s relationship with the Dow and other cryptocurrencies can’t be denied.