Cryptocurrencies and market crashes are words commonly used in the same sentences, especially in recent times.
The cryptocurrency market has crashed in the last few months (as of 1st December 2022) following the fallout of the cryptocurrency exchange FTX.
Consequently, the stock market is going through a rough patch as well, but for different reasons. But does the fallout in the crypto market affect the stock market?
What will happen when the more stable stock market falls? Would a stock market crash affect crypto?
What are cryptocurrency markets?
Trading cryptocurrency is either purchasing and selling the underlying coins on an exchange or betting on the price fluctuations of cryptocurrencies via a Contract for Difference (CFD) trading account.
The cryptocurrency market is decentralized since cryptocurrencies are neither issued nor guaranteed by any government or centralized institution. They are instead distributed throughout a computer network. Nonetheless, cryptocurrency ‘exchanges’ and ‘wallets’ allow for the purchase and sale of the currency.
You acquire the coins themselves when you buy cryptocurrency on an exchange. So if you want to buy cryptocurrency tokens, you’ll need to register a trading account on an exchange, deposit the entire amount of the asset, and keep them in a wallet until you’re ready to sell.
Cryptocurrencies are the most volatile investment option right now. Even the most stable crypto, bitcoin, is highly volatile.
The cryptocurrency markets are known for their substantial falls, parallel to the enormous rise they often see. The most recent example of a cryptocurrency crash is when the world’s formerly second-largest crypto exchange FTX crashed.
What happens to crypto if the stock market crashes?
The stock markets crashed due to the Coronavirus outbreak. Sensex, India’s stock market index, started reflecting a crash as early as mid-February 2022. On 20th February 2022, the Sensex was at 41,170 points. In just two months, it fell as low as 27,590, a 33% decline.
What happened to the cryptocurrency market during this time period? Let us take the case of Bitcoin, the biggest and most popular cryptocurrency in the world, to understand this.
Take a look at the above graph. As you can see, bitcoin reacted immediately to the news of covid-19 outbreak like the stock market did. The value of Bitcoin fell about 46% in a matter of a month.
But to analyze this we may need to have a bigger sample size. So, let us study the case of Ethereum as well. Take a look at the graph below.
As you can see from the graph, the case of Ethereum was similar to that of Bitcoin as well. Again, similar to Bitcoin, the coin’s value fell around 47% in a month.
From the two examples above, it can be seen that the crypto market, in general, immediately led to the stock market crash of 2020.
Market watchers were taken aback by how rapidly stocks rebounded. Given how swiftly the world shifted to digital, the fact that stock market indexes are highly weighted toward technology businesses does explain a lot.
However, the story was different in the crypto community. Most people were shocked by Bitcoin’s almost stock-like performance in the wake of the crypto market meltdown. After all, Bitcoin has long been considered a hedge against conventional asset classes like equities and precious metals due to the belief that it was uncorrelated.
What will happen if the stock markets crash again?
Even though the above example suggests some relationship between stocks and the crypto market, many believe that the exact needs to be more of a sample size to understand the relationship.
But If the stock markets crashed again, as they have in the past, historical data suggests that the cryptocurrency markets would also undergo a similar decline.
Well what if, instead, the stock market falls and people instantly start putting their money into cryptocurrency?
In any case, this seems very improbable, even without the benefit of March 2020 hindsight.
As a result, cryptocurrency is still widely seen as a very risky investment, and its viability as a refuge during times of economic turmoil is primarily theoretical.
Nonetheless, the events after the collapse may provide food for thought on market relationships. Consider the possibility that the stock markets don’t bounce back as expected this time. Since the pandemic impact has already been included in market prices, this scenario is more likely than it was in March 2020, when there was much more uncertainty.
What to do when cryptocurrencies fall?
When investing in speculative assets like cryptocurrency, it is not recommended to put in more money than you can afford to lose.
The rule of thumb is to allocate no more than 10% of your portfolio to high-risk investments. But if you have already invested in crypto, it is never a good idea to divest at the first sign of a bear.
Rather, it is advisable to wait, especially if you have invested in strong cryptocurrencies such as Bitcoins.
The above graph suggests that bitcoins prices have, so far, come back after dips. You could wait for such a correction to divest.
But similar to all market-linked investment options, past performance may not always be indicative of how the market performs in the future.
Hence, it is recommended to gauge the current market situation as well before making a choice. Also, you have to understand the market thoroughly when you invest in cryptos during times of market crash.
Conclusion
Even though the sample size is smaller to thoroughly identify what will happen to the crypto markets when the stock markets crash, history suggests a clear connection between the performance of the two.
