What we can learn from the latest Bitcoin-S&P correlation spike

Quick take:

  • Bitcoin’s correlation with S&P 500 is currently at a 2-year high
  • Over the past 5 years, this correlation appears cyclical, moving from negative to positive
  • Historically, spikes in correlation between Bitcoin and S&P 500 have often come at major downturns from the crypto market
  • On the other hand, Bitcoin’s growing decoupling from Wall Street often signalled a market-wide recovery in the past

In just the last 7 days, the entire crypto market cap dwindled by 33.7%, as the coronavirus morphed from a regional outbreak to global pandemic at a frightening pace.

The recent plunge has proved even more ‘impressive’ over on Wall Street, as 3 of the worst 10 days in the S&P 500’s history have now occurred within the last week alone.

In a word, everything is down, putting into question Bitcoin’s reputation as a safe haven asset in times of economic downturn.

In fact, it is Bitcoin’s latest inability to resist the ‘coronavirus effect’ that made us take a deeper look at the coin’s long-term correlation with the S&P 500 index. So we crunched the numbers for the past 5 years, and discovered some compelling insights about the relationship between the two financial markets - and what it could tell us about where we go from here.

A Tale of Two Financial Markets

Within the last week, Bitcoin’s correlation with the S&P 500 index ballooned to a 2-year high, and is currently hovering at 0.6:

BTC vs S&P500 30 days rolling correlation

A quick cheat-sheet for reading the above graph:

  • 1 -> BTC and S&P move identically
  • 0 -> BTC and S&P move completely independent from each other
  • -1 -> BTC and S&P move move in opposite directions

As you can see, the positive correlation between Bitcoin and the S&P index is now the highest it’s been since February 2018, when the world’s largest cryptocurrency abruptly ended its ATH rally by dropping all the way to $7600 in a month’s time.

Historically, the graph shows a repeating, almost cyclical pattern of sharp ebbs and flows between the two asset classes. In fact, plotting these correlation cycles over Bitcoin’s price action produces some very interesting results:

BTC price (orange) vs rolling correlation (blue)

The blue line depicts the 30-day rolling correlation between Bitcoin and S&P, while the familiar orange line represents Bitcoin’s rollercoaster price action over the last 5 years.

A closer examination of previous correlation spikes paints a compelling narrative: based on historical data, it would appear that the two asset classes inch closer to each other during major Bitcoin corrections. Here’s a few examples of this phenomenon as marked on the chart:

1 . The pattern is perhaps most evident at the previous ATH for the BTC-S&P 500 correlation, recorded in February 2018. As Bitcoin lost over $8000 in value in a span of 30 days, its correlation to S&P grew exponentially - from 0.1 to 0.6.

2. During Bitcoin’s july 2018 top (~$8180) the correlation hovered around 0; it promptly spiked to 0.5 as the king coin dumped to $6350 and went into consolidation.

3. More recently, as Bitcoin grew to an interim top of $9,300 in early November 2019, its correlation with S&P dangled at a respective 0.1. When it finally bottomed out at $6611 on December 16th, the correlation grew all the way to 0.3

Put simply, a number of major downturns in Bitcoin’s recent history were mirrored by a rising correlation to the S&P 500 index

But that’s only half the story.

Analyzing the historical BTC-S&P correlation gives us another vital insight - perhaps even more important given the current market situation. In each of the above cases, Bitcoin’s subsequent bounce-back was foreshadowed by a growing ‘decoupling’ between BTC and S&P 500:

1. After Bitcoin bottomed out at $7600 in February 2018, its correlation to the S&P started declining along with its recovery, falling to 0.4 as the coin bounced back to $10700. There was a similar drop-off around Bitcoin’s next bottom in April 2018 ($6850) - the correlation plunged to -0.2, after which BTC started rallying back to $9300.

2. After Bitcoin bottomed out at $3485 in December 2018, its correlation to the S&P dwindled from 0.4 to -0.3 over the next two months, as Bitcoin went from consolidation and into its 2019 rally.

3. After Bitcoin bottomed out at $6611 in December 2019, its correlation to the S&P started trending south, finally bottoming itself at -0.4 as BTC was commencing its 2020 pump.

While the similarities between these events in Bitcoin’s half-life are striking, it’s worth noting that no strategy is right 100% of the time, and this one is no exception. There have been various instances when the rising correlation between Bitcoin and S&P 500 didn’t result in the coin’s correction - like in February or June 2019 - as Bitcoin bucked the trend and continued pumping anyway.

So what does this backtest tell us about the current market predicament? Well, if history is to judge, two things may happen next:

1. Bitcoin will recover faster than the stock market.

While this may read more like a holistic than data-centered argument, it’s a crucial one nonetheless.

Crypto is a new type of economy, one that facilitates the production of digital value designed to be distributed in a pure, peer-to-peer way. These and correlated factors have contributed to swift recovery of the crypto market in the past, and will no doubt do the same again.

On the other side of the coin, the traditional markets remain overburdened with too many moving parts. The Wall Street machinery is partially digital (notably the part responsible for the most growth in recent years) but the vast majority remains carpal, physical in nature.

The past few years have been a primer on the stark differences between traditional and crypto market cycles. The former has - at least comparatively - proved sluggish and bloated. For better or worse, crypto continues to churn out rapid-fire market cycles, each one teaching the community (developers, speculators, miners and others) a valuable lesson or two about the nascent market.

Beyond pure TA lines, crypto has also clearly usurped the innovation baton from Wall Street. Mining (PoW), staking (PoS and variations), decentralised governance (on protocol and app level), ICOs (and its recent tributaries), decentralised debt (DeFi) - and the list goes on. The progress doesn’t stop - it accelerates.

And last but not least, crypto’s mainstream appeal continues to flourish, as the technology - and the market - has entrenched itself in most of today’s developed world over the last 3 years.

The stage is set, in my opinion, for the rapid growth - and recovery - of the decentralised P2P economy.

2. The declining correlation between Bitcoin and S&P will serve as a leading indicator for the crypto-wide bounceback.

As Bitcoin remains a de-facto proxy for the whole crypto market, its next decoupling from the S&P 500 index may be a preliminary sign of market-wide recovery. While no single indicator tells the whole story, the dwindling correlation between BTC and Wall Street may well be a strong signal to fire up your TA and fundamental models, and start paying closer attention to the forces that be.

If you want to keep track of the Bitcoin-S&P correlation and get notified when it starts dropping again (indicating a potential bounceback), send us an email at [email protected]

Thanks for reading!

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