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We’ve repeatedly hammered home the point that the growing financialization of the Bitcoin ecosystem is having an unintended impact in the form of elevated correlation with the rest of the risky asset universe. While such synergies do not matter in an overall bullish market, they do take away from Bitcoin’s “digital gold” credentials in times of turmoil.
📊 Throughout 2022, #Bitcoin has had a tight correlation with the #SP500. They spent the first half of the year declining before a recovery began in June. Lately, $BTC has fallen behind, and historically, a smaller reliance is good for #crypto long-term. https://t.co/EBwzLy8XqD pic.twitter.com/mz0hJbmZCc
— Santiment (@santimentfeed) August 9, 2022
Now, however, it appears that Bitcoin’s elevated correlation with the benchmark S&P 500 index is finally receding. As noted by Santiment in the tweet above, Bitcoin is lagging the S&P 500 in the ongoing bear market rally.
Moreover, Bitcoin’s 60-day correlation with the benchmark equity index, as tabulated by CoinMetrics, is now hovering at around 51 percent. For context, this metric hovered at around 75 percent back in May. In fact, Bitcoin’s correlation with the broader S&P 500 index is now back at the February 2022 levels. Nonetheless, we would like to see a sustained decline in this metric before pronouncing a definitive break between the world’s largest cryptocurrency and the world’s most liquid equity index.
As we’ve explained previously, Bitcoin’s elevated correlation with US equities is a symptom of the increased institutional presence in its ecosystem. During the initial phases of the ongoing bear market rout, the correlation between Bitcoin and growth-focused stocks gained prominence as a result of synchronous liquidation waves, where institutional investors dumped their Bitcoin holdings to finance margin calls on their other drowning positions. These liquidation waves then served to reinforce the still-tenuous connection between Bitcoin and US equities. By May, however, this mentality reigned supreme, leading to a persistently high correlation between Bitcoin and growth-focused US stocks.
We had explained in a previous post that a spot Bitcoin ETF would be a double-edged sword, given that it would unleash substantially higher institutional inflows into Bitcoin, but at the expense of a terminally higher correlation with the broader risky asset universe.
The SEC has so far only approved futures-based Bitcoin ETFs. BTC futures usually move at a premium of between 5 and 15 percent relative to the spot price. This is known as contango and is spurred by the implied financing rate, the time left to contract maturity, perceived volatility, etc. This leads to a forward curve that is upward sloping. ETFs that invest in futures have to roll over the front-month contract as it approaches expiration by buying one at the tail end. For example, consider a scenario where an ETF retains exposure to six consecutive monthly contracts. Also, assume that the January contract is nearing expiration. Consequently, the ETF would buy the July contract, with the February one becoming the front-month contract. However, due to contango, the ETF would be buying the July contract at a price that is at a substantial premium to the spot price. Over time, should contango persist, this practice leads to higher costs and ETF underperformance relative to the spot price. Due to this phenomenon, the futures-based Bitcoin investment avenues are not conducive to large-scale institutional adoption.
While the SEC is yet to approve a spot Bitcoin ETF, BlackRock has just launched a spot Bitcoin private trust that would allow its institutional clients the ability to track the price of the world’s largest cryptocurrency without the drawbacks associated with the futures contracts.
Bear in mind that earlier in August, BlackRock had entered into a partnership with Coinbase. Under the terms, Coinbase will allow BlackRock’s institutional clients access to the wider crypto sphere, starting with Bitcoin.
While these developments are sure to translate into elevated inflows for Bitcoin, they will likely also pump up the cryptocurrency’s correlation with the broader risk universe. Consequently, it remains to be seen how far the current slump in this correlation metric lasts.
Do you think a greater institutional role in the Bitcoin ecosystem is a positive development? Let us know your thoughts in the comments section below.