Innovation in technology brought to us the cryptocurrency market. Though there was an initial hesitation by investors to accepting it, it has now become an asset everyone is watching closely. Is the attention on this new asset taking away investors from the stock market? or has the emergence of crypto assets drawn the attention of millennials and other investors to the stock market? Read on to answer these questions.
First, An Explanation of What the Crypto Market & Stock Market Are About
For those that still see cryptocurrencies as an enigma, here is what they are; cryptocurrencies are virtual/digital currencies created as a means of exchange on a platform called blockchain. They are virtual assets based on networks that are distributed across many computers. This decentralized structure allows the currencies to exist outside the control of governments and financial regulators. The first and most popular cryptocurrency is Bitcoin, Bitcoin emerged in 2010 and since its introduction, thousands of other cryptocurrencies (Ethereum, Ripple, Litecoin, Binance coin etc.) with various functions have emerged.
The cryptocurrency market is the market where cryptocurrencies are traded. Like we stock exchanges in the stock market, we have cryptocurrency exchanges in the crypto market, cryptocurrency exchanges are platforms that enable individuals buy, sell & exchange cryptocurrencies for other digital or traditional currencies, these exchanges exist on websites and mobile applications. Examples of crypto exchanges are: Coin base, Binance, Kraken, Bitfinex, Luno etc. Most cryptocurrency exchanges are subject to government anti-money laundering regulations, and customers are required to provide proof of identity when opening an account.
The stock market on the other hand, is the market where company stocks/shares are traded. The stock market is made up of stock exchanges located in different countries around the world e.g., the New York Stock Exchange (NYSE), Nasdaq etc. Shares and stocks are units of a company and these units are traded on the stock exchange. Companies in a bid to raise money to fund or expand their operations, list shares on the stock exchange through a process called Initial Public Offer (IPO), giving investors the opportunity to purchase their shares, after the IPO, the listed shares are traded daily on the stock exchange.
Now that we know what both markets are about, how are they different?
A few things distinguish the crypto market from the stock market:
Traded Assets: Assets traded in both markets are quite different, shares are traded in the stock market while cryptocurrencies are traded in the crypto market. Shareholders are part owners of the company shares they own, as shares represent equity in a company. Cryptocurrencies on the other hand, are digital currencies, holders of cryptocurrencies do not own the company that issued them.
Regulation: The stock market is a regulated market, there are conditions to be met before a company can list on an exchange. And after listing, the stock exchange and the Securities and Exchange Commission (SEC) keeps a close eye on the activities of listed companies to ensure shareholders interest are preserved. Companies listed on the exchange operate in different sectors of the economy and these companies are also under the watch of regulatory bodies in charge of those sectors.
One of the main attractions of the crypto market is that it is unregulated. Cryptocurrencies were created to break away from the tradition structures of finance and so they are decentralized. The operate without regulation from any government or monetary authority. Regulation we expect will come to play in the crypto market in time.
Value: The value of company shares is determined by the financial performance of the company, revenue and profits generated by listed companies are used to determine their worth and the price their shares are traded.
Cryptocurrencies are not backed by valuables; so, it is a bit difficult to determine their true value. Some cryptocurrencies are valued based on their functionality, others based on the volume of trade. This makes their valuation subjective and so their true worth is unknown.
Volatility: The cryptocurrency market is an emerging market, it is not as liquid as other financial markets, it is also a very speculative market, its size and speculative nature makes the market susceptible to wild price swings. The stock market has been around for hundreds of years, so it has become an institution. There are rules guiding trading on stock exchanges, prices cannot go beyond certain points in a trading session. This and the liquidity of the stock market limits its volatility. The lack of controls in the crypto market makes it very volatile.
Recent Trends in the Crypto & Stock Market
Looking at the movement of prices in both markets, they seem to move in the same direction. To put this in context, lets see how the S & P 500 index (the index that tracks the performance of the 500 most capitalized stocks listed on the NYSE) & the Nasdaq 100 index (this index tracks the performance of the 100 largest non-financial companies listed on the Nasdaq stock exchange) performed in 2020 in comparison with the movement of Bitcoin (the most popular cryptocurrency) in the same period.
The above line chart shows the trend in Bitcoin, S &P 500 & Nasdaq 100 all through 2020, and this shows that aside from October 2020 when S & P 500 & Nasdaq 100 were negative and Bitcoin was positive, in every other month all line graphs moved in the same directions all through the year, even though Bitcoin seem more aggressive in its movement than the stock indices.
To further make this point clear, let’s see how the 3 have performed so far in 2021.
Except for April, they all seem to have moved in the same direction so far in 2021. In another research done by Inherent Wealth Fund (a wealth management company in America) earlier this year, in 55 trading days, Bitcoin and the S & P 500 traded in the same direction 70% of the time. Before now, this was not the trend, in 2018 & 2019 Bitcoin was on a down trend while, the S & P 500 & Nasdaq 100 closed both years higher than they opened them.
We believe the reason for the similarity in their movement from 2020 till date, is most likely the entrance of institutional investors into the crypto space and the entrance of more retail traders into the US stock market. Institutional investors who already hold stocks in their portfolios, diversified by including cryptocurrencies (especially Bitcoin) to their holdings in 2020. While retail investors who already hold cryptos, gained entrance into the US stock market through stock trading apps in 2020. Both markets had new entrants in them in 2020.
Also, the creation of cryptocurrency indices and Exchange Traded Funds (ETFs) listed for trading on stock exchanges maybe responsible for this similarity in trend. Though these indices and ETFs are not yet heavy weights (i.e., they are not large in terms of market capitalization) on the stock market, risk adverse investors see them as safe havens and will rather take position in them than directly invest in cryptocurrencies.
Will this Trend Continue into the Future?
This is hard to tell, the cryptocurrency market is still emerging, and so it is difficult to predict its direction in the coming years. It is however clear that as we progress into the future, more cryptocurrency themed financial assets will be created and listed for trading on stock exchanges, this we believe may drive both markets in similar directions.
How Do I as an Investor Take Position in both Markets?
The cryptocurrency market and the stock market trade high risk assets. Although high risk translates to high returns, it also means due diligence is required before investing in any of these assets. Do your research, understand your risk profile (your ability and willingness to take risk) before taking position in any of these markets.