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Could Cryptocurrencies Imploding Tank The Stock Markets?

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Chris Harvey, Wells Fargo Securities Head of Equity Strategy, has been on CNBC multiple times over the past month discussing his concern that weakness in cryptocurrencies could spill over into the equity markets. He believes that if risk is priced aggressively in one part of the market then it should be priced aggressively in other parts. This is the risk on vs. risk off trade being correlated between asset classes. (Note for this article I’ve abbreviated cryptocurrencies as CCs).

[Ed note: Investing in cryptocoins or tokens is highly speculative and the market is largely unregulated. Anyone considering it should be prepared to lose their entire investment.]

His thinking is that with CCs exhibiting very strong appreciation, they are a risk on bet (hard to argue with that). Then, if they fall and become risk off, other investments should also become risk off and therefore drop. He believes that “everything” is priced relative to each other and that all assets should be “related.”

There are good reasons that various asset classes are similarly valued versus another. One example is shares of companies that are competitors. If they have similar financial ratios, their valuation metrics tend to be close to each other’s.

Another example is shares of companies that are not competitors having different financial metrics. One company has high growth on its top and bottom lines. The other is growing slower. You will tend to see the high growth company have higher valuation metrics than the slow growth one.

Coincidence or correlation

The major question: Is there a correlation between CCs and other assets, or is it just a coincidence? Bitcoin’s price took off in the May to June timeframe last year, and it wasn’t until November that the bulk of the other CCs joined the party.

The NASDAQ is probably the equity market that would probably be the most correlated to the CCs. The NASDAQ had a steady climb the past year, as did most of the equity markets. The explosive run-up in CCs didn’t seem to have an additional positive impact on the equity markets at the end of last year, and the CCs downdraft since the beginning of the year has been in the opposite direction of the NASDAQ.

From Monday to Wednesday this past week, the CCs market capitalization went from $700 billion to just above $400 billion, per Coinmarketcap.com. While the NASDAQ took a dip of less than 1% on Tuesday (it was closed on Monday for the Martin Luther King holiday), it rebounded on Wednesday and closed up for the week.

There could be some short-term linkage between Bitcoin’s price movements and the stock markets, but I believe it is weak. Bitcoin could help or hurt a small number of stocks but I don’t believe it will tank the stock markets.

Retail investor vs. institutional firms

It is pretty well assumed that individuals own Bitcoin and other CCs. Consumers can even use credit cards to buy them. FOMO, or fear of missing out, is a major driver of individuals buying CCs. It would not be surprising to see retail investors decide to sell if there are large price declines, which then feed on themselves. A small number of investors could be hurt a lot.

For CCs to be correlated to the equity markets I believe they would need to be widely held by large investment firms. There may be some limited ownership of CCs by them, but I believe the Fidelity’s of the investment world have a very small amount of their funds, if any, in them. Index funds have also become a very large player in the equity markets and they do not own CCs.

CC ownership appears to be very concentrated

It appears that ownership of Bitcoins is very concentrated. This graph from Howmuch.net is from September last year, but I suspect it hasn’t changed dramatically. It does have some limitations in that a single address can represent more than one person. Think of a Bitcoin exchange or wallet.

What it shows is that if there is problem or a rush for the exits from one or a small number of CC owners that a large number of CCs could hit the market and dramatically impact pricing. This could create a short-term hit on the stock markets, but I don’t think it would be a lasting one.

Bitcoin ownership

Howmuch.net

Please feel free to check out my other Forbes articles “9 Reasons Bitcoin Could Hit $100,000 Or More” and “12 Reasons Bitcoin Could Fall Below $1,000” regarding digital currencies.