Is the Bitcoin and Stock Market Crash Related?

Script(ish) for the Video:

Today we’re going to talk about the decline in not only Bitcoin, but also the stock market and bonds. I think it’s kind of interesting to talk about whether or not this decline in other asset classes is positive for cryptocurrencies.

Before we continue though, I’d like to acknowledge it’s been a while since I’ve made my last video. I’ve been fairly busy, some things related to the channel and other things just being life… But if you want to keep up to date with me, check my Twitter because I post there more frequently, especially when I am MIA on this channel. Also… I am finally using Trading View, hoorah! I know everyone’s been waiting for that. Let’s get into the video…

Now 2018 has not been kind to Bitcoin – we started the year at roughly $14,000 and had a nice run up to $17,000 before all hell broke loose and we saw the market decline over 60% from the peak very rapidly, although it is worth noting that it didn’t fall as quickly as when we initially went up to $20k.

There are a number of theories out there as to why prices began to decline. Some speculate that it is due to China extending their ban to “exchange-like” services, others attribute it to the possibility of a ban on cryptocurrencies in India (or FUD surrounding that event) … Yet another group believes that prices are being manipulated by Wall Street through the use of cash-settled futures offered by CME Group and the Chicago Board Options Exchange. Then we have less specific catalysts like the idea that January has historically been a bad month for cryptocurrencies, so basically the January effect from stocks. Some argue it is a coordinated result from several or all of these catalysts.

The important detail here is that there is no “single” catalyst that anyone can definitely declare is the cause of prices declining, unlike back in September of last year where we saw Bitcoin decline due to the ICO ban in China and the subsequent exchange ban.

What this suggests to me is prices were simply too inflated and only needed an excuse to decline. What do I mean by this? I mean that everyone sort of knew that Bitcoin and other cryptocurrencies were overinflated (at least most people) and yet despite this, they kept buying in just so they wouldn’t miss out or to hopefully ride the wave a bit longer. In other words, price was driven by the Greater Fool theory.

This type of mentality is actually quite similar to what we saw with Ponzi schemes like Bitconnect, where people are aware it’s a scam and invest anyway in the hopes of profiting prior to the collapse. This is almost exactly what I am doing as I invest in Bitcoin despite believing it to be a bubble (which is different from being a scam, for the record).

Now that the momentum is definitely to the downside, the mirage has faded and many are panic selling. But there’s also another subcategory of sellers who are only selling for the possibility of buying in cheaper soon after. In other words, they are trying to take advantage of the downward momentum in the same way that many people tried taking advantage of the upward momentum in the second half of 2017. And just like what we saw with the inflation of the Bitcoin bubble in 2017, this subcategory of sellers is actually contributing to the overall strength of the price fall. In other words, they are contributing to the crash despite being net positive on cryptocurrencies.

This combined with the much louder voice of naysayers has led to a heavily bearish tone for Bitcoin and other cryptocurrencies. Just as we saw Bitcoin’ers drown out the naysayers while price was skyrocketing, suddenly the so-called “no-coiners” (or whatever you wanna call em) are beginning to drown out the Bitcoin’ers. All markets are about balance. I mean they talk about equilibrium of supply and demand from the very beginning when it comes to price discovery. Exceptionally emotional markets like Bitcoin tend to sway one way or another and they almost always are tipped out of balance just by human nature. And indeed, it seems that the pendulum has now swung the other way.

Meanwhile, the past two weeks has not been kind to stocks. In the US, we’ve seen the S&P 500 decline x% since January 26th and the DOW dropped 1,175 points on February 5th, the most it ever has in history on an absolute level. We saw a recovery the following day, but the rest of the week has been shaky so far and with the VIX being as high as it, the market has become a much less stable place.

Many investors are attempting to understand this decline, blaming a number of factors such as inflation expectations, increasing interest rates, government deficits that never seem to end and possibly most importantly, algorithmic trading.

A lot of people are speculating that due to the large bets placed on continued low volatility in the stock markets (as measured by VIX) as well as automatic portfolio rebalancing, there was significant sell off caused by algorithmic trading. The market also moved below its 50 day moving average, a critical support level that many bots likely are configured to spot and respond to accordingly.

Regardless of the cause, however, the frothy global stock markets are finally seeing a decline after not only record prices, but also exceptionally high valuations as shown by Shiller PE.

Meanwhile, the bond bubble started to deflate in the past month as treasury yields increased (for those of you unfamiliar, bond prices have an inverse relationship with interest rates, meaning they decline as rates increase or vice versa). However, we saw bond prices start to recover a little following the decline in the stock market as investors fled to safety but overall the trend is that bond prices are falling.

… And speaking of safety, gold has held strong during this decline and illustrates very clearly why Bitcoin is NOT digital gold as it is far too volatile and not yet perceived unanimously as a hedge against not only geopolitical risk, but more importantly (and this is what gold is really all about) hedging against monetary and systemic risk. Peter Schiff and other gold bugs are having a field day with this, finally receiving validation for their controversial views, although they tend to be a tad extreme for my tastes.

This all leads us to the important question: What should you do as an investor in this market? Is the broader sell-off in other asset classes a positive for Bitcoin? Unfortunately, I tend to think it likely isn’t. What used to be a unique opportunity for Bitcoin and other cryptocurrencies among a class of investors who watched it skyrocket without them is now a ubiquitous opportunity in other asset classes as well. In other words, there is now competition for where to buy the dip.

The other important factor is that the recent sell-off was clearly a risk-off trade as we saw equities broadly sell-off with defensive stocks outperforming other sectors and bonds saw a slight uptick before coming back down the rest of the week. If investors are going more risk-off, this would imply less capital for Bitcoin given its obvious more risky nature.

One last question that many have been asking: Is the sell-off in stocks related with Bitcoin? I’m going to have go with a big fat NO on that one – there is far too many variables at play and cryptocurrencies at this point in time are far too small to have such an impact in my opinion.

If you’ve followed my content a while, you know that I bought my last batch of Bitcoin at $8,300 with no plans to sell. You also know I used a majority of the cash I have allocated to cryptocurrencies when Bitcoin reached that level. However, I will be shifting some funds from outside of my cryptocurrency portfolio if we see Bitcoin come down to around $5,000 or lower (which no longer seems likely, fortunately).

Now the reason I’m not buying above $5,000 anymore is because I’m fully allocated to Bitcoin at this stage and really only want to increase that allocation in the event that there is an exceptionally attractive buy opportunity. Note that if I didn’t have a position in Bitcoin right now, I would have been buying it below $8,000. So this is a portfolio specific decision – and I really want to put emphasis on this because different portfolios should make different decisions.

This is a tough concept for many of you who are new to investing, but the best way to manage risk in a volatile asset like Bitcoin is to just limit your exposure to it and occasionally take profits when good opportunities arise. This way 60% declines like we have seen recently don’t devastate you entirely. The flip side is you won’t always make as much money when prices go up of course, but behavioral finance has illustrated to us that the pain of a loss is twice as bad as the good feelings associated with a gain so you want your portfolio to reflect that.

My strategy right now is focused on identifying altcoins that depreciate against Bitcoin and then moving some of my existing Bitcoin position over into that altcoin. In other words, I’m not dedicating new capital anymore, just moving around existing capital. I’d also like to note that altcoins held up exceptionally well this particular crash, with Bitcoin dominance never eclipsing above 40%.

This is a harsh blow to my estimate that Bitcoin dominance will rise to 50% in the coming months. I have previously stated on this channel that dominance tends to rise during either extreme crashes or spikes for Bitcoin. While dominance did in-fact climb slightly from 33% to around 38%, it never came close to returning over 45%.

The relatively small altcoin selloff (as measured by a rotation into Bitcoin) is still a topic I’m forming opinions about. I’m leaning toward the idea that it suggests the overall market wasn’t as panicked as the sell-off may have implied, which is also supported by the fact that the market fell slower than it went up.

There are other explanations as well, such as the recent news that Bittrex recently announced that they will be allowing USD deposits on their platform at some point in the future, allowing direct trading for altcoins and hence hurting one of Bitcoin’s primary use cases. There’s also the common explanation that Bitcoin is worse than useless due to its speed and transaction costs, meaning that it’s time of dominance has come to an end. I am still weary of this idea because it fails to acknowledge that most altcoins aren’t too useful either and possibly more importantly, haven’t been tested at the same scale as Bitcoin. As a result, I think it will take a longer time horizon to prove either side of this argument correct.

As to where the market goes from here, it’s anyone’s guess as to whether or not the “bottom” is in. There are some positive signs of a recovery such as the fact that volume remained relatively strong on the bounce back compared to other bounces we’ve seen recently. Volume is tepid now as we have moved from capitulation to consolidation.

I still stand by my original thoughts that the end of the bubble isn’t here yet. Many investors missed out on last year’s crazy bull run and Bitcoin is now on their radars. I suspect this group of investors will be the source of the next rise up in Bitcoin before we see a real and more extended bear market Bitcoin and other cryptocurrencies (assuming of course that their utility continues to grow at its current lackluster pace, which is a big assumption). What are your thoughts on the market?