For many investors in crypto, this is their first foray into investing in the markets and starting to understand monetary policy. While most people are drawn in by the prospect of increased returns or jpegs of monkeys, the last thing they ever expected was to understand market theory.
The crypto market, like every other free market, is based on liquidity, supply, and demand. When there’s low liquidity the price is highly volatile because small movements in trades can have large effects. For instance, if you dump $100 million of BTC on the crypto market the price will plummet much more than if you dumped the same value of US Dollars on the Foreign Exchange market.
Although this aspect of the markets is fairly easy to understand many people struggle with the concept of market correlations. Why for instance the crypto market is affected by the stock market, and what the S&P 500 have to do with cryptocurrencies.
Often correlation and causation can be confused. Just because two things react at the same time doesn’t necessarily mean that one is causing an effect on the other. There have been many dramatic examples of this phenomenon, such as the correlation between the number of films Nicolas Cage appears in correlated at one time to the number of drownings in swimming pools. Another correlation showed that between 2000–2008 as cheese consumption per capita increased so did the number of people who died after becoming entangled in their bedsheets.
Similar correlations occur between the stock market and the crypto market and although these may share similar causes they haven’t been shown to be a direct cause of one another. As the S&P 500 drops crypto markets usually also drop, and as it picks up so too does the crypto market. This is why many traders look at their cryptocurrency investments and trades in the context of the wider markets. To help comprehend this relationship it’s useful to understand a little about the S&P 500.
The S&P 500 was created by Standard & Poor, a US-based financial intelligence company. It’s an index of the market that tracks 500 leading companies that are listed on the stock exchange in the US. The idea behind the S&P 500 is that by aggregating the ups and downs of these 500 companies it gives an insight into how the markets, in general, are doing.
In September 2021 the nine largest companies within the S&P 500 accounted for over 28% of the combined value of all 500. Of particular interest to the cryptocurrency market is the fact that these nine companies are all involved in tech or finance. They are Apple, Microsoft, Alphabet, Amazon, Meta, Tesla, Nvidia, Berkshire Hathaway, and JP Morgan Chase.
There is a significant overlap between people who invest in tech and financial stocks and people who invest in crypto. This is especially so when you look at the institutional investors that drove a significant increase in the liquidity of the crypto bull run in 2021.
In addition, last year JP Morgan Chase opened crypto trading to all of its wealth management clients, Tesla added BTC to its balance sheet, Facebook rebranded to Meta as it pushed harder with its metaverse development, and Berkshire Hathaway has just acquired Nubank, a digital bank that specializes in cryptocurrencies.
In addition to the businesses themselves, if their investors sense a difficult road ahead they are likely to try and sell their stocks. When this happens in a large enough volume the stock prices fall. If they’re also holding crypto they will more than likely seek to sell this too, however, the liquidity in crypto is lower than the S&P 500, so it’s likely to have a greater effect.
The combination of these factors gives rise to the appearance that when the S&P 500 goes down, so too crypto markets go down. Due to the differences in liquidity of the respective markets, it will also appear that crypto goes down harder and faster than the S&P 500. To outside observers, it’s easy to think that the S&P 500 is causing the crypto market to go up or down, but this coupling of the markets may well be due to the fact that they share similar high-value investors.
A key point for retail investors to bear in mind is that high-net-worth investors can have a huge impact on the crypto markets. For those who have forgotten the 2008 financial crash that caused the collapse of Lehman Brothers bank, it’s also worth remembering the role of federal insurance in US banks.
The Federal Deposit Insurance Corporation (FDIC) guarantees to protect up to $250,000 of each person’s funds that are deposited in an FDIC-insured bank should the bank fail. Whilst this sounds like a significant amount for most retail investors when you have $10+ million to find a safe harbor for, it’s not reassuring. Those fortunate individuals use wealth management services that invest in the markets for them, spreading their risk.
As soon as risk changes their investment portfolio changes too. This is why you’ll see an increase in stock prices and crypto prices when the macroeconomic picture looks positive and a drop in both when it looks uncertain. The advantage of tracking the S&P 500 is that it’s far more stable than the crypto markets and the analysts that study it are far more qualified than most crypto influencers.
In general, the factors that affect the S&P 500 also affect the crypto markets, which is why you’ll often hear it referenced alongside analysis of cryptocurrencies. If someone is claiming the crypto bottom is in and a bull run is around the corner it’s worthwhile checking what analysts specializing in the S&P 500 say. Although they’re not directly linked you can stay one step ahead by following the S&P 500 rather than a YouTuber with no formal training in technical analysis.
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