Teenage Bitcoin throws an interest rate tantrum

This drift towards the mainstream, driven by the big bets of institutional investors, has seen bitcoin become sensitive to interest rates and fuelled a sell-off in the coin this month as investors braced for a hawkish Federal Reserve policy meeting.

The cryptocurrency, born in 2009, was still on the fringes of finance during the Fed’s previous tightening cycle, from 2016 to 2019, and was barely correlated with the stock market. Times have changed.

Bitcoin has been positively correlated with the S&P 500 index since early 2020, according to Refinitiv data, meaning they broadly move up and down together. Their correlation coefficient has risen to 0.41 now from 0.1 in September, where zero means no correlation and 1 implies perfectly synchronised movement.

By contrast, that coefficient was just 0.01 in 2017-2019, according to an International Monetary Fund analysis published this month.

“Now that bitcoin is not entirely held by early adopters, it’s sitting in a 60/40 type portfolio,” said Ben McMillan, chief investment officer of Arizona-based IDX Digital Assets, referring to the institutional strategy of allocating 60% of a portfolio to relatively risky equities and 40% towards bonds.

“It’s not surprising that it’s starting to trade with a lot more sensitivity to interest rates.” Bitcoin closed below the $40,000-mark for the first time since August 2021 on Friday, some way off its November peak of $69,000.

The crypto market is increasingly being characterised by big investors, rather than the smaller retail players who drove its early movements.

The total assets under management of institutionally focused crypto investment products rose in 2021 from $36 billion in January to $58 billion in December, according to data provider CryptoCompare.

On top of this, there was bumper buying from the corporate likes of Tesla and MicroStrategy, plus hedge funds adding crypto to their portfolios.

“The cryptocurrency ecosystem grew from a total market valuation of $767 billion at the start of the year to $2.22 trillion by the end of the year,” CryptoCompare said.

The drift towards mainstream finance raises broader questions in 2022 and beyond about whether bitcoin can retain its role as a diversification play and hedge against inflation.

IMF researchers said bitcoin’s increasing correlation with stocks limited its “perceived risk diversification benefits and raises the risk of contagion across financial markets”.