Executive Summary
Bitcoin moves in the direction of global liquidity 83% of the time over any 12-month period, surpassing other major asset classes, making it a strong indicator of liquidity conditions. Despite some short-term deviations due to unique events or internal market shifts, Bitcoin's correlation with global liquidity remains significant, particularly during valuation extremes. By combining global liquidity metrics with Bitcoin's on-chain data, investors can better understand Bitcoin's market cycles and identify moments when its price may diverge from liquidity trends.
Understanding Global Liquidity's Impact
In today's financial world, asset prices increasingly depend on central bank policies and liquidity conditions rather than just fundamentals. Post-Global Financial Crisis (GFC), unconventional monetary policies have largely driven asset movements. Essentially, more available money leads to higher prices for assets like stocks, bonds, gold, and Bitcoin. Central banks have significantly increased the fiat currency supply since 2008, leading to asset price inflation.
Recognizing how to measure global liquidity and how assets respond to liquidity changes is crucial for investors navigating these markets.
Measuring Global Liquidity
Various methods exist to measure global liquidity, with global M2 being a broad indicator, encompassing physical currency, checking accounts, savings, and more. Bitcoin Magazine Pro aggregates data from major economies—such as the United States, China, and the Eurozone—to gauge global M2 in U.S. dollars, providing a reliable measure of global liquidity.
Why Bitcoin is a Key Liquidity Indicator
Historically, Bitcoin shows a strong relationship with global liquidity: thriving as liquidity expands and suffering when it contracts. Thus, Bitcoin can be seen as a 'liquidity barometer.' Its price movements often align with changes in global liquidity, showcasing its sensitivity to such shifts.
In risk-on environments, investors typically favor risk assets like Bitcoin, while tightening liquidity conditions push investors towards safer assets. Stocks and gold, while correlated with liquidity, face influences like earnings and safe-haven demand, respectively, making their correlation with liquidity less pure than Bitcoin's.
Quantifying Bitcoin's Correlation
Between May 2013 and July 2024, Bitcoin displayed a strong sensitivity to liquidity, with a 0.94 correlation, highlighting its predictable response to global liquidity shifts. However, shorter-term analyses show a moderate correlation, suggesting occasional divergences driven by specific market events or dynamics.
Bitcoin's Directional Consistency
Bitcoin's price direction aligns with global liquidity trends 83% of the time over 12-month periods, surpassing other asset classes. This indicates global liquidity significantly influences Bitcoin's price long-term, offering traders a vehicle to express views on liquidity conditions.
Divergences and Supply-Side Dynamics
Despite Bitcoin's strong correlation, internal dynamics or unique events can cause temporary divergences. Idiosyncratic events, such as major hacks or regulatory changes, may lead to sudden market shifts.
Supply-side patterns also affect Bitcoin's liquidity correlation. During bull markets, long-term holders often sell, impacting correlation. Metrics like the Market Value to Realized Value (MVRV) Z-Score help identify extreme valuation levels, offering insight into these divergences.
Conclusion
Bitcoin's robust correlation with global liquidity positions it as a valuable economic indicator. While not flawless, combining liquidity analysis with Bitcoin's on-chain data offers deeper insights into its price cycles. As central banks continue influencing markets, understanding liquidity shifts remains critical for investors, with Bitcoin serving as a reliable barometer of economic conditions.
Appendix
Interestingly, international equity ETFs like EEM and VT showed weaker liquidity correlations compared to the S&P 500, challenging traditional views on expressing liquidity conditions through Emerging Markets. Bitcoin, as a decentralized asset, remains less impacted by regional instability, offering a consistent gauge of global liquidity.
