Why Do Altcoins Fall When Bitcoin Sets New Highs?

Bitcoin has been on a parabolic run in the last few days as prices crossed above $13,000 for the first time since June 2019. At the time of writing, the bellwether cryptocurrency has just retreated back to $13,200 after marking a new one-year high of $13,850. Bitcoin's recent volatility upsurged has set record volumes across major exchanges as traders jump in to catch every bit of action. 

In contrast, Altcoins have been relatively muted despite modest gains coat-tailing on Bitcoin's momentum. To put it in perspective, Bitcoin has gained more than 30% since the sharp correction in early September. Meanwhile, large-cap Altcoins such as Ethereum, Ripple, EOS, and Chainlink have underperformed and have yet to break new highs. In particular, DeFi-related coins have performed the worst and continued to fall in value despite Bitcoin's bullish momentum. 

Source: Tradingview

This peculiar market movement has left many investors scratching their heads as Bitcoin, and Altcoins' correlation weakens. Many investors expect Bitcoin’s upsurge to positively impact altcoins as well. However, this has not happened. We have seen it time and time again, cryptocurrencies react in several different ways to Bitcoin's price movement. 

Bitcoin’s Dominance Surged

In recent days, Bitcoin's dominance has marked a new three-month high after hitting a low of 55%. This indicator represents Bitcoin's market capitalization as a percentage of the entire crypto industry. A high ratio indicates that more capital flows into Bitcoin, and vice versa.

Since Bitcoin's halving event, which took place in June, the bellwether cryptocurrency has been relatively inactive, with periods of suppressed volatility. In this period, Altcoins had dominated headlines. In particular, the DeFi space was the primary source of returns for most crypto traders. From June to August, traders raked in profits from Altcoins month after month, forcing Bitcoin's dominance to fall below 60% for the first time since the start of the year. As a result, Bitcoin became ‘under-owned’ in contrast to altcoins. 

Source: Tradingview

The altcoin euphoria was short-lived as September brought along the bears. Since mid-September, Bitcoin has regained dominance. Currently, Bitcoin maintains a 62.8% dominance of the entire crypto market while the altcoins struggle with 37.2%.

Bitcoin’s rising dominance ensued as investors’ confidence grew, particularly among institutional investors. There has been no shortage of positive developments for Bitcoin. Corporates such as Microstrategy and Square have purchased Bitcoins as their treasury asset. While recently, Paypal announced its decision to offer cryptocurrency services, enabling millions of its customer base to buy and sell Bitcoins. Even Singapore’s largest bank, DBS, has joined the foray and announced plans to launch its own crypto exchange. This growing institutional demand has driven prices higher, crossing above $13,000 for the first time in more than a year.

Meanwhile, Bitcoin has managed to brush off any negative news, including BitMEX's charges and OKEx's withdrawal saga. Its resilience has had many analysts believing that the upsurge is just the beginning of a new bull cycle for the bellwether cryptocurrency.

Source: Glassnode

The number of Bitcoin whales (large investors) with 1000 BTC and above continues to rise. The increasing number is a positive sign as it reduces the circulating supply, potentially weakening any bearish sentiment. Whales could be anticipating a strong medium to long-term Bitcoin price trend and are choosing to hold on to Bitcoin.

Source: Tradingview

The increasing institutional interest has spurred a positive impact on Bitcoin, at the expense of Altcoins. Even Ethereum (ETH), the second-largest cryptocurrency, was not spared. In August, ETH traded near the $500 mark, reaching $485 for the first time in two years. In the last two months, Ether lost over 20% of its value, and market dominance dropped from above 14% to 11.3%. However, speculation in the market is that the upcoming ETH 2.0 Phase 0 could provide the needed boost for Ether bulls.

Read more: What is The Potential Impact of Ethereum 2.0 on The Derivatives Market?

Meanwhile, the hype around DeFi projects continues to die down, especially as token prices plummets. Data shows that trading volume and total value locked in Decentralized Exchanges (DEXs), is declining rapidly. Data from DeFi Pulse shows the total value locked is currently at $11 billion, a slight drop from the all-time high at $12.4 billion. As the hype around DeFi recedes, Bitcoin is once again in the spotlight. All eyes are set on Bitcoin as it continues to trek to a new 2020 high. 

Bitcoin’s Correlation With Altcoins Weakened

Since mid-September, Bitcoin's performance has diverged away from Altcoins. Although the entire crypto market took a hit after the massive sell-off in September, it seems that Bitcoin has emerged the strongest. While Altcoins may lag behind, historical data suggests that altcoins will eventually catch up, making it a value-buy. The correlation between Bitcoin and large-cap altcoins dipped lower on the October 20th, as Bitcoin surged out of range. This indicates capital rotation between altcoins to bitcoin in this period. 

Source: Coinmetrics.io

Indeed, data has indicated Bitcoin's resurging dominance resulting in altcoins’ underperformance, which begs the question, why do altcoins fall when bitcoin sets new highs?

Market Moves and Herd Mentality

Often people invest irrationally on the basis of psychological bias rather than market fundamentals. When the price of a particular coin is rising or the overall demand is growing, they go long. When a crypto has gained considerable value, say 20% or 30%, investors tend to overestimate its future expected return and have a fear of losing out. Such behavior is so common that it influences the prices of individual cryptocurrencies, causing disproportionate upward and downward movements.

This phenomenon is still prevalent in crypto markets. As Bitcoin explodes into action, traders hope to catch every bit of its momentum. Consequently, moving capital from altcoins to bitcoins. This FOMO behavior often leaves Altcoins in the dust, causing temporary underperformance and short-term mispricing. For well-informed traders, however, it opens up opportunities.

This effect is similar to how traditional currency markets work. Suppose the US Dollar gains significant momentum. If you want to jump in for a quick profit, in this case, you would have to convert your local currencies to US Dollars. Imagine everyone in the market piling into the US Dollar simultaneously. This behavior can significantly impact both the base and quote currencies. In traditional currency markets, when the US Dollar strengthens/weakens, other currencies such as EUR, AUD, or CAD move in the opposite direction. The same applies to cryptocurrencies. When there is a demand imbalance for Bitcoin, Altcoins would be significantly impacted.

Mainstream acceptance

Regardless of your opinion on Bitcoin, you can't deny that Bitcoin is by far the most popular cryptocurrency. Bitcoin is the largest cryptocurrency by market capitalization at $250 billion. Meanwhile, Ethereum, the industry's second-largest cryptocurrency, pales in comparison at $50 billion — one-fifth Bitcoin's size.

Such is the sheer size of Bitcoin's dominance. In fact, people outside of crypto often refer to "Cryptocurrencies" as "Bitcoin," thinking that they are one and the same. To this day, Bitcoin continues to be the yardstick by which all other cryptos are measured. 

Especially in recent times where mainstream financial institutions are jumping into the crypto bandwagon, the first cryptocurrency being offered would be Bitcoin. Several high-profile, well-known investors, such as Paul Tudor Jones, have publicly expressed their bullish views on Bitcoin, further popularizing the bellwether cryptocurrency.

Therefore, when new money flows into the market, it is likely that new investors would put their money into the cryptocurrency they've heard of the most, which is Bitcoin. Bitcoin is still the king of crypto – and it is hard to believe it will be dethroned anytime soon.

Trading market cycles to your advantage

The lead-lag relationship between Bitcoin and Altcoins is primarily driven by greed and FOMO. As capital moves away from altcoins, it presents a buying opportunity for well-informed traders to own altcoins while prices are still relatively low.

At present, Bitcoin is well above $13,000. Ethereum, Bitcoin Cash, and Litecoin are slowly creeping their way up as well. However, many mid-cap altcoins have not seen similar gains. Coins that lag behind may offer buying opportunities. In this scenario, you can compare the relative value between the leader (Bitcoin) against the laggard (non-performing altcoin) and analyze the trade's risk/reward. 

Ultimately, if you can identify what part of the market cycle we are in, you’ll be able to lock in relatively consistent returns.