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Bitcoin is telling us what the S&P 500 will do.

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Bitcoin is telling us what the S&P 500 will do.

Heightened sensitivity to the credit cycle makes bitcoin a reliable, but not always accurate economic fire alarm.

Nik Bhatia
and
Joe Consorti
Aug 5, 2022
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Bitcoin is telling us what the S&P 500 will do.

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Dear readers,

As a research provider, we bring you rates data paired with bitcoin price study and analysis—why do we do this? Apart from our fascination with bitcoin and our belief that it’s propelling itself towards world reserve currency status, it’s because rates lead everything, and bitcoin leads equities. Providing a two-pronged analysis of these areas allows us to probabilistically determine what lies 3-6 months ahead in markets. In that vein, let’s explore why bitcoin is telling us what the S&P 500 will do.


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Bitcoin leads the S&P 500

Over the last half-decade, bitcoin has had a large enough market capitalization and wide enough media coverage to be discussed in the same sentence as major equity indices like the S&P 500 [SPX]. Bitcoin is traded in size by large funds (like equities are), and positions are scaled into and out of just like a riskier tech stock. Large funds are the entities that really move bitcoin’s price around—as much as we believe that its absolute scarcity and immutable protocol rules put it in the “commodity” category alongside precious metals, these large funds with billions of dollars in tradeable liquidity are calling the shots.

In risk-off periods, when selling bitcoin into a much shallower market than equities (and probably in much larger size due to the perceived risk of bitcoin), large entities move a much larger proportion of their bitcoin than they do equities. As a function of this, and a similar behavioral trend across the market, bitcoin tops tend to lead SPX tops.

Time Between Bitcoin & S&P 500 Cycle Tops

You’ll note that the degree of earliness varies considerably, with 5 weeks of lead time for bitcoin at the narrowest and 34 weeks of lead time at the widest—a result of the magnitude of the selloff in each asset respectively. For example, $1 billion of sell pressure from a large fund can set off a behavioral chain of reflexive selling in bitcoin as participants watch the price fall meaningfully and hurriedly sell their holdings, whereas the same amount of sell pressure in the S&P 500 would be little more than a 0.5% intraday move and nothing to worry about for the average market participant.

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Bitcoin also has more sensitivity to the credit cycle than SPX, with bitcoin responding to tightened borrowing conditions well in advance of stocks.

Bitcoin topped 8 weeks before the risk-free rate started rising.

Bitcoin & 3m T-Bill Yield

The S&P 500 topped the exact same week that the risk-free rate started rising.

S&P 500 & 3m T-Bill Yield

Bitcoin leads traditional risk assets, represented here by the S&P 500—making it an accurate economic bellwether, but not necessarily a reliable one. If we looked to bitcoin as our gauge for the direction of economic conditions, we would regularly be sounding false alarms about the credit cycle. In 2018 and 2019 when bitcoin experienced two 50%+ drawdowns, other risk assets did not follow, and Treasury yields did not rise. This makes bitcoin more like a fire alarm than a tornado warning — as people often pull fire alarms when there is, in fact, no fire.

Why is bitcoin more sensitive to the credit cycle than the S&P 500? There are two main reasons.

1. Lower Liquidity Profile

Bitcoin has a market cap of $457 billion, compared to the S&P 500 much larger market cap of $36 trillion — said otherwise, bitcoin is a measly 1.27% the size of the S&P 500.

S&P 500 Market Cap & Bitcoin Market Cap

As markets move into a risk-on appetite, bitcoin rises considerably faster and earlier than the S&P 500, as liquidity parked in the former drives the price with much higher velocity than the same amount of money in the latter. The same goes for de-risking periods (like the one which began in late 2021): money drawn from risk assets drives bitcoin down faster and earlier than the S&P 500.

2. Excessive Leverage & Speculation [Higher Percentage of Market Cap is Derivatives]

  • S&P 500 Futures Aggregate Open Interest is only 0.00067% of the size of its market cap.

  • Bitcoin Futures Aggregate Open Interest is 2.47% of the size of its market cap.

  • Comparatively, that means bitcoin’s derivative profile compared to its overall liquidity is 3,686 times larger than that of the S&P 500.

This high leverage and speculation relative to the S&P 500, a basket of risk assets, leads to extremely high sensitivity to factors that move risk assets. Note once more, bitcoin fell 8 full weeks before the risk-free rate started rising, a microcosm of this dynamic.

These two factors in tandem lead to bitcoin’s trademark volatile price swings—in time, the liquidity profile of bitcoin will ostensibly expand on its way to becoming a world reserve currency, and a low liquidity profile will no longer be an issue that contributes to bitcoin’s high degree of price volatility. Admittedly, we anticipate that speculation and high leverage will persist for years to come, as well as the discrepancy in market cap between bitcoin and stocks. This should keep volatility elevated throughout the decade (sorry if you were dreaming of calmer markets).

Bitcoin will continue having a marginally higher sensitivity to extraneous risk factors than other risk assets, even as its liquidity deepens and it approaches a comparable level to other major reserve assets like gold and major equity indices.

This free post is a preview of paid content frequently provided for paying subscribers of The Bitcoin Layer.

Bracing the downside and facing the upside

Bitcoin 365-day S&P 500 Correlation

Over a 365-day rolling correlation, observe that bitcoin decouples to the downside rather heavily during major drawdowns, a dynamic of the lower liquidity profile and excessive leverage discussed above. This creates periods of extreme unwind in bitcoin that aren’t present in the S&P 500 to the same extent. On the other side, bitcoin rarely ever reaches beyond a 75% correlation during its parabolic price increases—another function of its liquidity/leverage profile, causing bitcoin to see far more upside gain than the S&P 500 during times of marketwide risk-on behavior.

Decoupling to the downside, protracted and intense decoupling to the upside: this is the time-tested reality of bitcoin.

Bitcoin & S&P 500 Comparative % Returns

Bitcoin has outperformed the S&P 500 over every time horizon longer than 730 days, and if you’re looking for an investable vehicle to store and appreciate your wealth, chances are you’ll be staying in the market for well over two years. Over time, this informational arbitrage of an absolutely scarce commodity trading like an infinitely reproducible tech stock will wane. You can take advantage of this extreme upside by scaling in during extreme downside before the aforementioned major funds catch on to this informational arbitrage — and with BlackRock (the world’s largest asset management corporation with $10 trillion AUM) teaming up with Coinbase to offer bitcoin to its clients, they are catching on.

Until next time,

Nik & Joe

This free post is a preview of paid content frequently provided for paying subscribers of The Bitcoin Layer.


This post was sponsored by Voltage, provider of enterprise-grade Bitcoin infrastructure.

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