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Most of the time, we all have observed that cryptocurrencies rise or fall trailing the equity markets. But before the pandemic, the largest cryptocurrencies, Bitcoin and Ethereum, hardly resonated with major stock indices. The broader market started to change after the central bank crisis in response to the 2020 economic breakdown. The correlation coefficient of their daily moves was just 0.01, which jumped to 0.36 for 2020-21, according to a report by the International Monetary Fund (IMF). The assets either rose together or fell together. This can potentially be due to the limited risk diversification benefits which investors might be looking for.
But when investors started to initiate wide-range sell-offs across equity markets in response to the rising US inflation in mid-May, the price of cryptocurrencies also tumbled. However, there were other reasons why crypto was falling. The reason behind this correlation is that both markets are volatile in nature. And the correlation becomes even more significant as most factors affecting equities also affect the cryptos. Here are some of those prominent factors.
Supply and Demand
When we talk about supply and demand, it affects both the markets, whether the equities or cryptocurrencies. With a supply cap of 21 million Bitcoins and a rising demand, the price is driven higher. Similarly, even shares of listed companies are limited. Let us look at Berkshire Hathaway Inc., for example. This company has never done a stock split. The share price has been rising with increasing demand for the past couple of decades now.
Market Sentiment
In all markets, there are two sets of investors—ones who are optimistic about the price while others are pessimistic. We have bulls and bears in crypto and stock markets who either drive the price high or contribute to the price declines due to various reasons.
Policies and Regulation
The changes in the monetary policies or regulations across the globe impact financial markets. Recently, the US Federal Reserve hiking the prices to tackle the rising inflation has resulted in a downward trend both in the stock as well as the crypto market. Any policy around the money or the economy of the country is likely to impact the price movements of the volatile assets. With the Chinese government pressuring the mining farm operators to shut down, Bitcoin fell drastically in 2021 July.
Geopolitical Tensions
We all witnessed the heat of war between Ukraine and Russia in the first quarter of this year. The tension between both countries has resulted in fluctuations and instability in the volatile markets. However, since cryptos are even more volatile assets than stocks, they are the ones to be hit harder in situations like this. But with the situation getting better, we also witnessed a surge in the price actions across stocks and cryptos.
Market Movers
Whether stocks or cryptocurrencies, both the markets can be influenced by the same market movers, which can result in price hikes or declines. For example, Elon Musk can impact both markets with his tweets as he is a strong influencer of the Tesla company and also a widely recognized crypto advocator.
Conclusion
The price of the cryptocurrencies appears to be correlated with the equities because, as mentioned, most factors affecting equities also affect cryptos. Also, market participants and forces are inadvertently creating the correlation as both of the assets are volatile in nature and by treating cryptos similar to equities.
Author Bio
Mr. Edul Patel, CEO & Co-Founder, Mudrex - A Global Crypto Investment Platform.
LinkedIn: https://www.linkedin.com/in/edulpatel
Twitter: https://twitter.com/Dul_dul?s=08
Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.