Tuesday was a painful day for stock market investors, with the Dow Jones Industrial Average (^DJI -0.98%) falling more than 1,275 points and the S&P 500 (^GSPC -0.46%) and Nasdaq Composite (^IXIC -0.64%) dropping 4% to 5%. Market participants often hope for at least a modest bounce after a tough day, but Wednesday morning didn't suggest any such relief was forthcoming. Futures contracts on all three stock indexes were down slightly as of 8:15 a.m. ET.
Some investors in cryptocurrencies have believed that digital assets would be able to provide some valuable diversification in the event of a stock market decline. Unfortunately, that hasn't been the case over the past couple of years, as the prices of Bitcoin (BTC 0.64%) and other popular cryptocurrencies have tended to track closely in line with the Nasdaq. Now, though, some digital investors are asking whether Bitcoin and its peers can regain the positive momentum that took them to all-time highs last year even if stocks stay mired in a bear market.
Crypto winter continues
Cryptocurrencies certainly haven't escaped the rout that started on Tuesday. Bitcoin has fallen 11% in the past 24 hours and now stands just above the $20,000 mark. Ethereum (ETH 0.07%) is down almost 9% since this time Tuesday, falling back below $1,600 even as proponents of the smart-contract network point to the coming Merge event as a landmark moment for the digital asset.
Given the immediate cause of the sell-off across several asset classes, it's not terribly surprising to see Bitcoin, Ethereum, and their crypto peers losing significant ground. August's inflation reading of 0.1% didn't seem like all that big a deal, but given that it came in the face of plunging gasoline prices, many were surprised not to see a modest drop. Moreover, as signs of more entrenched inflationary pressures appeared in different categories of goods and services, market participants believed the odds were better that the Federal Reserve would raise interest rates even higher to protect the economy from allowing inflation to become a long-term problem.
Bitcoin has at times hailed itself as a hedge against inflation, given the fixed supply of the digital asset. However, now that a large financial market has emerged surrounding Bitcoin and other cryptocurrencies, the dynamics that affect institutional investors now play a key role in price movements. In particular, when interest rates rise, those investors who rely on borrowed money in order to make leveraged investments in cryptocurrencies often have to pull back from their positions.
Can crypto break off from the stock market?
In that light, cryptocurrencies have in some ways suffered from their success in becoming mainstream assets. As regular investors become involved in the crypto markets, their behavior influences prices in the same way it influences stock prices.
However, it's unfair to paint all cryptocurrencies with the same broad brushstroke. For Bitcoin and Ethereum, their notoriety and popularity make them more susceptible to broader financial market influences. But for smaller digital asset projects that are just getting started, fundamental aspects of whether newer cryptocurrencies can add value and provide useful applications for potential users can outweigh the influence of broad market trends.
Both Bitcoin and Ethereum would need to triple in price from current levels in order to set new all-time highs. Those abrupt upward cycles have happened numerous times in the past, so counting the pair of digital asset leaders out is ill advised. In order to break its connection to the stock market, though, the cryptocurrency world will once again have to persuade investors broadly that its vision of the future can overcome traditional macroeconomic challenges. That's a tall order, but those who've bet against digital asset innovators in the past haven't fared well over the long haul.
