While cryptocurrencies are among the most volatile assets, we have seen heightened volatility in crypto assets over the last year. So far, the volatility was largely towards the upside. However, things have turned upside down for crypto investors after China’s ban. What does the crash mean for stock markets?
The crash in cryptocurrencies was long overdue looking at the irrational exuberance and the almost one side upward movement. However, it isn't just crypto investors who are impacted by the crash. The massive fall in crypto assets has far-reaching implications.
Stocks impacted by the fall in cryptocurrencies
Some stocks are impacted directly by the fall in cryptocurrencies like Bitcoin. For example, MicroStrategy had 90,531 bitcoins at the last count on its balance sheet. No wonder, the stock is down sharply on May 19. Bitcoin has tumbled to multi-month lows. Tesla and Square also fall in this category and both of the companies hold Bitcoins.
The second category is the companies whose business is linked to cryptocurrencies. So, crypto exchange Coinbase is also falling on the news about China tightening the regulations on digital assets.
Then we have several cryptocurrency miners like Riot Blockchain and Marathon Digital which were market darlings when Bitcoin prices were rising. Now, since Bitcoin prices are falling, these stocks are also tumbling.
What the crypto crash means for U.S. stock markets
There's a nuanced relationship between stock markets and cryptocurrencies. Despite all of the talk about cryptocurrency assets being an alternate asset class, they have a high correlation with stock markets as they, like stocks, are risk assets. Bitcoin prices tumbled in the first quarter of 2020 when the U.S. stock markets crashed.
The fall in crypto assets will also lead to risk-off sentiments. The spillover is already visible in U.S. stock markets with the Nasdaq down sharply on May 19. Also, the risk-off sentiments are pushing bond yields higher, which is a negative for stock markets, especially growth stocks that have most of their earnings skewed to the future.
The crypto market has a market capitalization of nearly $2 trillion. The crash in that market is bound to send shockwaves in stock markets as well.
Stock markets react
U.S. stock markets are sharply lower on May 19. Along with the crypto crash, inflation fears are also weighing on the markets. Retail inflation in the U.K. jumped to 1.5 percent in April and more than doubled from 0.7 percent in March. While many people think that the rise in inflation is transitory amid supply-side disruptions and higher consumer demand, if inflation persists, it could prompt central banks globally to reconsider their accommodative monetary policy.
Treasury Secretary Janet Yellen has already advocated a rate hike even though she said that she respects the Fed’s independence. As Fed chair, Yellen started increasing the rates in December 2015, a policy current Fed Chair Jerome Powell continued before reversing course. A rate hike could play a spoiler with the stock markets by squeezing the flood of easy and cheap money that has helped drive stocks and other risk assets higher.
Silver lining in the crypto crash
Risk assets, including stocks and cryptocurrencies, are competitors when it comes to grabbing a share of investment wallets. The crash in crypto-assets and uncertainty about their regulations could mean that some investors pivot back to stocks from cryptocurrencies. For now, since cryptos and stocks were pals in the upcycle, they are falling in tandem too.