Cryptocurrency volatility: is it the canary in the coal mine?

Big swings in prices aren’t anything new for cryptocurrency traders – it’s generally par for the course, and typically proven a temporary phenomenon over recent years which has seen cryptos multiply in value very many times over. Nevertheless, the weekend’s moves in cryptocurrency markets were significant, with a major liquidation across the space driving the price of the likes of Bitcoin down as much as 26%, and Ethereum as much as 23%.

Crypto bulls will tell you it’s a blip; crypto sceptics will say it’s a blight on a supposed store of value. In the shorter-term, and more broadly, however, the more pertinent issue for traders might be what the price action implies for what are increasingly volatile financial markets.

Did stocks lead crypto? Or will crypto lead stocks?

Risky assets – and its fair to call cryptocurrencies risky assets still given their volatility profile – have come under selling pressure in the past week, as fears about the new Covid-19 variant Omicron and tighter US monetary policy weakens risk appetite. Given cryptos appeal as an alternative asset used to hedge inflation expectations, and have been fuelled, much like equities, by the tidal wave of liquidity pumped into markets by the US Fed, the former appears to be the big issue here. The question might be from here, whether the drop in cryptos was the proverbial flash in the pan and led by the weakness seen in US stocks on Friday night; or perhaps something of a forward-looking indicator for what may be in store for stocks in the weeks ahead, as investors – especially of the retail variety – flee from their investments.

Could a vicious cycle be on the cards for stocks and crypto?

It’s probably the case that some balance of both is driving crypto and equity markets, with the former likely to see more volatility given thinner liquidity. What traders will be wary of is the potential for a vicious cycle, whereby selling in one asset fuels selling in another. It’s highly likely that losses in stock portfolios last week triggered margin calls, which forced investors to liquidate their crypto assets to cover the losses. With many investors likely in a similar position with their crypto portfolios, it may be the case this week that they’ll be forced to sell some of their stock portfolios to cover the crypto losses. If sentiment remains weak in financial markets, this dynamic could self-perpetuate for a time, leading to a steeper drop from here in both cryptos and equities.

In the bigger picture, it will depend on how the Fed approaches monetary policy at its final meeting for the year in a fortnight’s time, coupled with developments with Omicron, whether equities and cryptos continue to trend lower. In the more immediate future, higher volatility, price dislocations and technicals could drive weakness in both.

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