Bitcoin: The 'barometer' of global liquidity?

The liquidity of the crypto market was tight, and Bitcoin fell again after continuing to fluctuate, hitting a low of US$86,000, down nearly 20% from its peak. Bitcoin, the leader in cryptocurrency, has caused altcoins to collapse, and market sentiment has also shifted from fanaticism to panic.

Is the Bitcoin bull market over? What is the future trend? These issues have attracted much attention. But Bitcoin trends are closely linked to global financial markets, and Swan Bitcoin research analyst Sam Callahan's article on the relationship between Bitcoin price and global liquidity is worth reading.

Core point of view of the article: Bitcoin price is consistent with global liquidity trends 83% of the time, which is higher than other major assets, making it an effective indicator for measuring liquidity conditions.

Although Bitcoin is highly correlated with global liquidity, it is not completely unaffected by short-term volatility, especially during extreme valuations, and is susceptible to interference from specific events or internal market factors.

Combining global liquidity and Bitcoin chain valuation indicators can help investors to understand Bitcoin's cycle changes more carefully, helping investors identify moments when internal market dynamics may lead to Bitcoin's short-term deviation from liquidity trends.

Understanding how asset prices fluctuate with changes in global liquidity is crucial to investors and helps improve returns and manage risks effectively. Under the current market environment, central bank policies directly affect asset prices, liquidity has become the main driving factor, and fundamental analysis is no longer sufficient.

Since the 2008 financial crisis, unconventional monetary policy has become the dominant force in driving asset prices. The central bank has dominated the market trend by regulating liquidity leverage. As economist Mohamed El-Erian said, the central bank has become the "only protagonist".

Stanley Druckenmiller also agrees with this view, pointing out: "Returns cannot drive the overall market; it is the Federal Reserve...watch the central bank and the changes in liquidity...Most people in the market are looking for returns and traditional indicators, and what drives the market is actually liquidity."

The close connection between the S&P 500 and global liquidity further confirms this.

The chart shows a simple supply-demand relationship: when funds are abundant, asset prices rise; when funds are tight, asset prices fall. Since 2008, the central bank has injected a large amount of fiat currency into the market, and asset prices have risen accordingly, and monetary inflation has driven asset price inflation.

Therefore, understanding how to measure global liquidity and the responses of different assets to liquidity changes has become the key for investors to deal with liquidity-driven markets.

How to measure global liquidity

There are various methods to measure global liquidity. This article uses the global M2 - a broad money supply indicator, covering easy-to-acquire cash such as physical currency, current deposits, savings deposits, money market securities, etc.

Bitcoin Magazine Pro provides a global M2 measurement method that summarizes data from eight major economies: the United States, China, the euro zone, the United Kingdom, Japan, Canada, Russia and Australia. This indicator can effectively reflect global liquidity because it reflects the total amount of funds available for expenditure, investment and borrowing around the world and can be regarded as a measure of global credit creation and total amount of central bank money printing.

It should be noted that global M2 is denominated in US dollars. Lyn Alden explains the importance of this: the strength of the US dollar as a global reserve currency is crucial. When the US dollar strengthens, the debt burden of countries increases; when the US dollar weakens, the debt burden reduces. The global broad money supply denominated in US dollars is a key indicator for measuring global liquidity.

When global M2 is denominated in US dollars, it not only reflects the relative strength of the US dollar, but also reflects the speed of credit creation, making it a reliable indicator for evaluating global liquidity conditions.

While there are other ways to measure global liquidity, such as considering short-term government debt or global foreign exchange swap markets, in this article, “global liquidity” refers to “global M2.”

Why Bitcoin may be the purest liquidity barometer

Bitcoin shows a strong correlation with global liquidity. Bitcoin usually performs strongly when liquidity expands; Bitcoin performs poorly when liquidity shrinks, so it is called a "liquidity barometer."

The following figure clearly shows the consistency between Bitcoin price and global liquidity changes.

Comparing Bitcoin with annual year-on-year changes in global liquidity further highlights the close relationship between the two.

Chart shows that Bitcoin prices are very sensitive to changes in global liquidity. But is it the most liquid-sensitive asset in the market?

The correlation between risky assets and liquidity is more significant. When liquidity is abundant, investors tend toward high-risk/high-return strategies; when liquidity tightens, investors turn to safer assets. This explains why stocks perform well when liquidity increases.

However, stock prices are also affected by other factors, such as earnings and dividends, which may undermine the sheer correlation between stocks and global liquidity. U.S. stocks are also affected by passive capital inflows in retirement accounts, which may provide a buffer when liquidity fluctuates, reducing their sensitivity to global liquidity conditions.

The relationship between gold and liquidity is more complex, which benefits from increased liquidity and weaker US dollar, and is also regarded as a safe-haven asset. As liquidity tightens, investors may increase demand for gold. Therefore, the performance of gold may not be closely related to liquidity conditions. Bonds are similar.

Bitcoin is different, it has no earnings or dividends, and no structural buying affects its performance. Most capital pools still view it as risky assets, which could keep Bitcoin relatively purely relevant in terms of global liquidity.

If this holds true, it is a valuable insight for Bitcoin investors and traders. Long-term holders can analyze the driving forces behind price trends more deeply; traders can use Bitcoin to express their views on the future direction of global liquidity.

This article aims to explore in-depth the correlation between Bitcoin and global liquidity, compare its relationship with other asset classes, identify periods of disruption in correlation, and share insights into how investors can use this information to gain advantages in the future.

Quantitize the correlation between Bitcoin and global liquidity

Analyzing the correlation between Bitcoin and global liquidity, the intensity and direction of the correlation must be considered at the same time. The intensity reveals the degree of synchronization between the two variables; the direction indicates whether the two change in the same direction or in the opposite direction.

Analyzing data from May 2013 to July 2024, Bitcoin is very sensitive to liquidity. During this period, the correlation between Bitcoin price and global liquidity reached 0.94, showing a strong positive correlation.

However, when the 12-month rolling correlation was observed, the mean correlation dropped to 0.51. The 6-month rolling correlation was observed, and the correlation further decreased to 0.36. This means that as the time frame shortens, the deviation between Bitcoin’s price and its long-term liquidity trend increases, suggesting that short-term price fluctuations are more likely to be affected by Bitcoin’s own specific factors.

To better understand the correlation between Bitcoin and global liquidity, we compared it with other assets, including the SPDR S&P 500 ETF (SPX), Pioneer Global Stock Index ETF (VT), iShares MSCI Emerging Market ETF (EEM), iShares 20+ Treasury ETF (TLT), Pioneer Total Bond Market ETF (BND), and Gold.

Bitcoin has the highest average correlation with global liquidity within a rolling 12-month time frame, followed by gold. Stock indexes have a slightly weak correlation, while bond indexes have the lowest correlation with liquidity.

When analyzing the correlation between assets and global liquidity by year-on-year changes, the correlation between stock indexes is slightly stronger than Bitcoin, followed by gold and bonds.

The reason why stocks may be more closely related to global liquidity in annual year-on-year changes is the high volatility of Bitcoin.

The above data emphasizes three key points:

1) The performance of stocks, gold and Bitcoin is closely related to global liquidity;

2) Bitcoin has a stronger overall correlation compared to other asset classes and has the highest correlation during the 12-month rolling period;

3) The correlation between Bitcoin and global liquidity will weaken when the time frame is shortened.

The consistency between Bitcoin and liquidity makes it unique. A strong positive correlation does not guarantee that both variables always move in the same direction. Examining the consistency of direction can provide a more comprehensive understanding of the interaction between Bitcoin and global M2.

Of all the assets analyzed, Bitcoin has the highest directional consistency with global liquidity. During the 12-month period, the probability of Bitcoin moving in the same direction with global liquidity is 83%, and 74% over the 6-month period.

The following figure further demonstrates the directional consistency between Bitcoin and global liquidity over the 12-month period, compared with other asset classes.

These findings are very important because they show that although the intensity of correlations may vary by time frame, the direction of Bitcoin’s price is often consistent with the direction of global liquidity. In addition, Bitcoin’s price direction is closer to global liquidity than any other traditional asset.

This analysis shows that the relationship between Bitcoin and global liquidity is not only significant in strength, but also very stable in directional consistency. Data shows that Bitcoin is more sensitive to liquidity conditions than other traditional assets, especially over a longer time frame.

For investors, this means that global liquidity may be a key driver of Bitcoin’s long-term price performance; for traders, this means that Bitcoin has become a highly sensitive investment vehicle to express views on global liquidity.

Identify breaks in Bitcoin's long-term liquidity relationship

Although Bitcoin has a strong overall correlation with global liquidity, its price tends to deviate from liquidity trends in a shorter rolling cycle. These biases may be due to internal market dynamics or specific events.

These individual events refer to events that occur within the wider crypto industry, often leading to rapid changes in market sentiment or triggering large-scale liquidation. For example, major bankruptcy, trading platform hacking, regulatory dynamics, or the collapse of Ponzi schemes.

Looking at the historical example of the weakening of the 12-month rolling correlation between Bitcoin and global liquidity, it is clear that the price of Bitcoin is often decoupled from liquidity trends when major industry events occur.

The COVID-19 market crash in 2020 provides another example. Bitcoin initially experienced a sharp decline amid widespread panic selling and risk aversion. However, Bitcoin rebounded rapidly as central banks took unprecedented liquidity injection measures, highlighting its sensitivity to liquidity changes.

Understanding the impact of these individual events on Bitcoin’s correlation with global liquidity is very important, but its unpredictability makes them less operable to investors.

How supply side dynamics affect Bitcoin’s liquidity correlation

Another significant pattern of weakening of Bitcoin’s liquidity correlation is that this situation often coincides with periods when Bitcoin’s price reaches extreme valuations and subsequent sharp declines.

The main source of available for sale is the profit exit of old holders when the price of Bitcoin rises. The key metric to evaluate this behavior is Bitcoin’s HODL Wave for one year and more.

Historically, this indicator usually declined during bull markets because long-term holders would choose to sell, while during bear markets it would rise because they would accumulate.

Marketing Value and Realization Value Z Score (MVRV Z-score) has proven to be an effective tool to identify whether Bitcoin has reached extreme valuation levels.

When MVRV Z-score is higher, it means there is a large gap between the market price and the realized price, and many holders enjoy unrealized profits, which may be a signal that Bitcoin is overvalued.

In contrast, when MVRV Z-score is lower, the market price is close to or below the realization price, which indicates that Bitcoin is undervalued.

When superimposing the 12-month rolling correlation between MVRV Z-score and Bitcoin and global liquidity, a clear pattern can begin to be identified. As MVRV Z-score drops sharply from historical highs, the 12-month rolling correlation seems to decline as well.

This suggests that internal market dynamics such as profit-taking and panic selling may have a greater impact on Bitcoin prices than global liquidity conditions when Bitcoin’s MVRV Z-score slides down from highs and its correlation with liquidity weakens.

By simultaneously monitoring the long-term correlation between Bitcoin and global liquidity and its MVRV Z-score, investors and traders are able to better predict how Bitcoin’s price responds to changes in liquidity conditions.

Conclusion

The strong correlation between Bitcoin and global liquidity makes it an important macroeconomic barometer. This correlation is not only strong, but also shows a high degree of directional consistency when compared to other asset classes.

However, Bitcoin’s correlation is not perfect. Internal market dynamics, such as unique shocks or extreme valuation levels, may cause Bitcoin to temporarily deviate from global liquidity conditions.

Combining global liquidity analysis with on-chain indicators such as MVRV Z-score helps to better understand Bitcoin’s price cycle.

The above is the detailed content of Bitcoin: The 'barometer' of global liquidity?. For more information, please follow other related articles on the PHP Chinese website!