And then the market crashed!

A brief take on recent events

On 24th May, the total cryptocurrency space’s market cap went from a high of $2.56T to $1.63T today – a 36% decline.

Hopefully, the above memes have given you a context as well as a good laugh. To further explain, the primary reasons for the big price correction in the crypto market on 19th May 2021, were 2-fold.

What spooked the markets?

The first announcement that created a dent in the market was when self-appointed CEO of Dogecoin and a Crypto market influencer, Elon Musk, announced on 12th May that the electric carmaker (Tesla) will not be accepting Bitcoin as payment — a reversal of an earlier decision. The reason he reversed his decision was due to climate change concerns.

Elon Musk’s tweet on Tesla’s future with Bitcoin

This development resulted in Bitcoin’s price falling by more than 10%, to just above $46,000, also resulting in the fall of Tesla shares. Mr. Musk’s tweet led to a fear in the minds of investors about the possibility of large sell-off (dump) by Tesla and other investors who were now looking to exit the crypto market. What traders and crypto enthusiasts failed to understand was that Elon Musk’s tweet further also said that he will not sell any of the acquired Bitcoins and intends to use it for transactions as soon as mining shifts to using more sustainable energy. Panic sellers, disregarding the latter portion of the tweet, started selling other crypto holdings as well. This resulted in price of ETH to fall to less than $3.5K and that of Doge to fall to $0.38 from its highest of $0.72 on 8 May 2021.

The final blow to the crypto market came on 19 May 2021, when three state-backed organizations of China, including the National Internet Finance Association of China, the China Banking Association and the Payment and Clearing Association of China, issued a warning on social media, which said that investors would not have any protection from losses in crypto-currency investment. They went on to add that recent fluctuation in crypto prices “seriously violate people’s asset safety”. It also barred financial institutions and payment companies from providing any services related to cryptocurrency transactions. This restricts the online trading platforms from offering services involving cryptocurrency, such as registration, trading, clearing and settlement.

The investors reacted to the news and the sell-off led to a crypto crash. As several trading platforms including Binance and Coinbase crashed, it led to further panic among investors. Bitcoin dropped below $40K from its all time high of more than $60K. Ethereum fell to $2.7K, its lowest since the end of April 2021 and Dogecoin $0.28 for a brief period, as it picked up slowly.

A surprising relation

With crypto markets largely in free fall, the stock market saw more declines on 19 May 2021, as investors dealt with a massive sell-off in the cryptocurrency market. Declines in major stock market indexes were not particularly large, but they did continue a downtrend that has been more pronounced recently. The Dow Jones Industrial Average (DJINDICES: ^DJI) was down 463 points to 33,598. The S&P 500 (SNPINDEX: ^GSPC) had dropped 54 points to 4,074 and the Nasdaq Composite (NASDAQINDEX: ^IXIC) had declined 116 points to 13,187.

Further, Crypto centric companies faced bigger losses and are highlighted as below: –

  • Crypto exchange Coinbase Global (NASDAQ: COIN), which was down 7%.
  • Crypto mining specialists Marathon Digital Holdings (NASDAQ: MARA) and Riot Blockchain (NASDAQ: RIOT), fell 10% and 8%, respectively.
  • Industry banking institution Silvergate Capital (NYSE:SI), although it managed to narrow its losses to 3%, after having been down as much as 10% earlier.
  • MicroStrategy (NASDAQ: MSTR), whose leveraged bets on cryptocurrencies have been well documented, saw its stock fall 9%.

Below, we check out the correlation between some of the most famous stock indices and crypto currencies since January 2021 to clearly quantify this relationship.

Correlation between crypto and various equity markets

What is seen, is that since the beginning of 2021, the correlation has been positive. Moving in future, the correlation may also become more prominent as traditional investors with a conservative approach to investment may enter the crypto market. A report by DataTrek Research implied the correlation in bitcoin (and crypto market) and stock market, becomes most eminent when sentiment, rather than core fundamentals, is the main operator of movements in the economic markets. Since the Pandemic, the number of stock and crypto market participants have increased. This was because market dips made stocks cheaper to buy and thus increased the ability to invest with lesser amounts, motivating younger and inexperienced investors to enter the financial market.

As per the study ‘Investing 2020: New Accounts and the People Who Opened Them’, most new investors i.e., those who opened a non-retirement investment account for the first time during 2020, were under the age of 45 and had lower incomes than investors who already owned taxable investment accounts prior to 2020. They also found that Investment knowledge was low for all groups, though particularly lower for new investors. On an average, new investors could only answer 1.4 out of 5 investment knowledge questions correctly. Thus, they were participating based on tips and advice given by well wishers -sentiment rather than market knowledge. Further readings also suggest a) Job losses across the globe owing to the pandemic are also leading people to invest in crypto to earn a passive income and, b) People are also investing their stimulus checks into crypto to take advantage of high gains.
Interestingly, this suggests that as the world of cryptocurrencies has exploded over the past year, so has its impact on actual companies and therefore financial markets.