Stock Market Struggles Test the Behavior of Digital Currencies Under Market Stress

On the morning of March 9, 2020, the US Securities and Exchange Commission (SEC) temporarily froze trading activity after the Dow Jones lost roughly 7% of its value within a few hours of the market opening. Several more of these circuit-breaker events followed in the ensuing weeks as uncertainties around the new coronavirus shook the global economy. As CNN explains, circuit-breaker events are designed to protect investors and the larger economy from catastrophic market crashes driven by mass panic. A decline of 13% will freeze trading again, and a 20% decline will cause trading to automatically cease for the remainder of the day.

Digital currency enthusiasts celebrate the lack of any form of regulation around digital currencies. Bitcoin is based on blockchain technology and has a decentralized governance model—there is no SEC to protect against panic, fraud, or market manipulation. Anything goes, short of conjuring money out of thin air or double-spending assets (rules codified in and enforced by Bitcoin’s underlying protocols). 

But the Bitcoin network has yet to weather a substantive financial downturn. In fact, the 2008 financial crisis was one of the motivating factors behind creating a decentralized currency in the first place. Twelve years later, Bitcoin is a household name, and hundreds of thousands of individuals have bought or sold it. 

The stock market’s struggles in the first quarter of 2020 are a real-time test of two different economic visions. Any business looking to build a long-term strategy around digital currencies should watch Bitcoin in the coming weeks to better understand the risks and opportunities—not just during the decline, but also during the market’s eventual recovery. 

The Value of Bitcoin Tracks the Traditional Stock Market

While it’s too early to say anything definitive about Bitcoin’s ability to withstand a financial crisis, a few informative patterns emerge. Bitcoin’s booms and busts broadly follow trends in the traditional stock market. Consider the two figures below, which show the price of Bitcoin and the S&P500 index over the previous 3 months. Each follows a similar trajectory, and the two recent dips in the S&P500 each correspond to a steep drop in the value of Bitcoin.

Bitcoin Market Price: January-March 2020

(Source: CoinMarketCap)

S&P 500 Index: January-March 2020

(Source: MarketWatch)

When the SEC stepped in to freeze trading in the opening hours of March 9, 2020, the S&P500 had lost about 7% of its value. It dropped another 18% from its February high by the end of March. Bitcoin, with no market regulation and no circuit-breaker, lost 35% of its value over the same period, falling from a high of $10,000 (also in February) to around $6,500 as of the end of March. 

This correlation suggests the two markets are not fully independent. The SEC’s regulatory efforts likely affect Bitcoin, even though Bitcoin itself is unregulated. The SEC takes action to calm investors, and there is substantial overlap in the investor pool between Bitcoin and the S&P500. At a minimum, it seems that investors do not consider Bitcoin to be any more secure or resilient than traditional stocks.

What Happens Next?

A full comparative analysis of Bitcoin and traditional stock markets must wait until the market stabilizes—and should be undertaken by financial analysts with a deep knowledge of these markets. However, observers should keep their eyes on a few key indicators:

• The volatility of Bitcoin and traditional markets compared under conditions of market stress
• The responses of the two markets during and after any regulatory interventions by the SEC
• The length of time each market needs to recover its pre-downturn value

The long-term success of digital currencies depends on their ability to perform predictably under a range of market conditions. HSB reports that 36% of small-to-medium-sized businesses accept Bitcoin payments. If businesses believe Bitcoin can hold its value and appreciate over time, they are more likely to accept it as payment for real goods and services, which could accelerate adoption. 

On the other hand, if Bitcoin can’t survive this crisis, risk-averse businesses may decide they are better off with state-backed currencies, regulated or not—and Bitcoin will remain a high risk investment intended for short-term gain.