Bitcoin has the highest correlation with global liquidity of all major asset classes.
By Sam Callahan
Compiled by: Luffy, Foresight News
summary
In any given 12-month period, Bitcoin’s direction is aligned with global liquidity 83% of the time, a higher rate than any other major asset class, making Bitcoin a barometer of liquidity.
Bitcoin has a high correlation with global liquidity, but is not immune to short-term deviations caused by special events or internal market dynamics.
Combining global liquidity conditions with Bitcoin on-chain valuation metrics provides a more nuanced view of Bitcoin cycles, helping investors identify situations where internal market dynamics may cause Bitcoin to decouple from global liquidity trends.
Correlation of major asset classes with global liquidity
Background
For investors who want to improve returns and effectively manage risks, it has become essential to understand how asset prices change with changes in global liquidity. In today's market, asset prices are increasingly affected by central bank policies that directly affect liquidity conditions. Fundamentals are no longer the main driver of asset prices.
This has become more evident since the global financial crisis. Since then, these unconventional monetary policies have become an increasingly dominant force driving asset prices. Central bankers have used liquidity levers to turn markets into one big trade, and central banks have become, in the words of economist Mohamed El-Elrian, “the only game in town.”
Stanley Druckenmiller echoed the same sentiment, saying, “Earnings don’t move the market, it’s the Fed that moves the market…Watch the central bank and where liquidity is going…Most people in the market are watching earnings and the regular indicators. Liquidity is what drives the market.”
This is particularly evident in the S&P 500.
Comparison of S&P 500 and Global M2
The correlation in the above chart can be attributed to simple supply and demand. If there is more money available to buy something, whether it is stocks, bonds, gold or Bitcoin, the price of these assets will generally rise. Since 2008, central banks have injected more fiat money into the financial system, and asset prices have responded accordingly. In other words, monetary inflation has fueled asset price inflation.
Against this backdrop, it is imperative that investors understand how to measure global liquidity and how different assets respond to changes in liquidity conditions in order to better navigate these liquidity-driven markets.
How to measure global liquidity
There are many ways to measure global liquidity, and for this report we will use Global M2: a broad measure of money supply that includes physical currency, checking accounts, savings deposits, money market securities, and other forms of easily accessible cash.
Bitcoin Magazine Pro provides a measure of global M2 that aggregates data from the eight largest economies: the United States, China, the Eurozone, the United Kingdom, Japan, Canada, Russia, and Australia. It is a good measure of global liquidity because it reflects the total amount of money available for spending, investing, and borrowing around the world. Another way to think about it is as a measure of the total amount of credit creation and money printing by central banks in the global economy.
One nuance here is that global M2 is denominated in USD. Lyn Alden explained why this is important in a previous article:
Dollar denominated money is important because the dollar is the world's reserve currency and therefore the primary unit of account for global trade, contracts, and debts. When the dollar is strong, countries' debts become stronger. When the dollar is weak, countries' debts become weaker. Global broad money denominated in dollars is like a great measure of world liquidity. How fast fiat currency units are created is how strong the dollar is relative to other global currency markets.
When global M2 is denominated in U.S. dollars, it captures both the relative strength of the dollar and the pace of credit creation, making it a reliable indicator of global liquidity conditions.
Why Bitcoin May Be the Purest Liquidity Barometer
Over the years, there is one asset that has shown a strong correlation with global liquidity: Bitcoin. As global liquidity expands, Bitcoin tends to thrive. Conversely, when liquidity contracts, Bitcoin also suffers. This phenomenon has led some to call Bitcoin a "liquidity barometer."
The chart below clearly shows how Bitcoin’s price tracks changes in global liquidity.
Similarly, comparing the year-over-year percentage changes in Bitcoin and global liquidity also highlights the synchronization of the two changes, with Bitcoin's price rising when liquidity increases and falling when liquidity decreases.
As can be seen from the above chart, Bitcoin’s price is highly sensitive to changes in global liquidity. But is it the most sensitive asset on the market today?
Generally speaking, risky assets have a higher correlation with liquidity conditions. In a liquidity environment, investors tend to adopt a risk-on strategy and move capital to assets with higher risk/return. Conversely, when liquidity tightens, investors generally move capital to assets they perceive as safer. This explains why assets such as stocks tend to perform well in an environment of increased liquidity.
However, stock prices are also affected by factors other than liquidity conditions. For example, stock performance is partly driven by factors such as earnings and dividends. This may weaken the correlation between stocks and global liquidity.
In addition, the U.S. stock market benefits from structured buying through passive inflows from retirement accounts such as 401(k)s, which further weighs on its performance regardless of liquidity conditions. These passive inflows can buffer the U.S. stock market when liquidity conditions fluctuate, potentially reducing its sensitivity to global liquidity conditions.
Gold's relationship with liquidity is more complex. On the one hand, gold benefits from increased liquidity and a weaker dollar, but on the other hand, gold is also seen as a safe haven asset. In times of shrinking liquidity and risk aversion, investors seek safety and demand for gold may increase. This means that even if liquidity weakens, gold prices can perform well. Therefore, gold's performance may not be as closely tied to liquidity conditions as other assets.
Like gold, bonds are considered a safe-haven asset, so their correlation with liquidity conditions may be low.
Finally, we return to Bitcoin. Unlike stocks, Bitcoin has no yield or dividends, and there are no structural purchases that affect its performance. Unlike gold and bonds, at this stage of Bitcoin's adoption cycle, most capital pools still view it as a risk asset. Relative to other assets, Bitcoin has the purest correlation with global liquidity.
If this is true, then this is a valuable conclusion for both Bitcoin investors and traders. For long-term holders, understanding Bitcoin’s correlation with liquidity can provide more insight into the drivers of its price over time. For traders, Bitcoin provides a tool to express views on the future direction of global liquidity.
This article aims to delve deeper into the correlation between Bitcoin and global liquidity, compare its relationship with other asset classes, identify periods when the correlation breaks down, and share how investors can use this information to profit in the future.
Quantifying the correlation between Bitcoin and global liquidity
When analyzing the correlation between Bitcoin and global liquidity, it is important to consider both the magnitude and direction of the correlation.
The size of the correlation indicates the degree of association between two variables. The higher the correlation, the more predictable the impact of changes in global M2 on Bitcoin prices. Understanding this degree of correlation is key to measuring Bitcoin's sensitivity to changes in global liquidity.
Bitcoin’s strong sensitivity to liquidity is evident based on data between May 2013 and July 2024. During this period, Bitcoin’s price had a correlation of 0.94 with global liquidity, reflecting a very strong positive correlation. This suggests that Bitcoin’s price was highly sensitive to changes in global liquidity during this time frame.
Looking at the 12-month rolling correlation, Bitcoin’s average correlation with global liquidity has dropped to 0.51. This is still a positive correlation, but significantly lower than the overall correlation.
Furthermore, when examining the 6-month rolling correlation, the correlation further drops to 0.36.
This shows that Bitcoin’s price deviates increasingly from its long-term liquidity trend as the time frame becomes shorter, suggesting that short-term price movements are more likely to be influenced by Bitcoin’s internal factors rather than liquidity conditions.
To better understand Bitcoin’s correlation with global liquidity, we compared it to other assets, including the SPDR S&P 500 ETF (SPX), Vanguard Total World Stock ETF (VT), iShares MSCI Emerging Markets ETF (EEM), iShares 20+ Year Treasury Bond ETF (TLT), Vanguard Total Bond Market ETF (BND), and gold.
In terms of 12-month rolling correlation, Bitcoin is the highest, followed by gold and then stock indices, while bond indices are the weakest correlated with liquidity.
When analyzing the correlation between assets and global liquidity based on year-over-year percentage changes, stock indices show a slightly stronger correlation than Bitcoin, followed by gold and bonds.
One reason why stocks may be more correlated with global liquidity than Bitcoin on a year-over-year percentage basis is that Bitcoin is highly volatile. Bitcoin's price often fluctuates significantly over a year, which can distort its correlation with global liquidity. In contrast, stock indexes often have less pronounced price fluctuations and more closely track year-over-year percentage changes in global M2. Nonetheless, Bitcoin's correlation with global liquidity is still quite strong on a year-over-year percentage change basis.
The above data shows three key points: 1) The performance of stocks, gold and Bitcoin is closely related to global liquidity; 2) Bitcoin's overall correlation is strong compared to other asset classes, and the correlation is highest over a 12-month rolling period; 3) As the time frame shortens, Bitcoin's correlation with global liquidity weakens.
Bitcoin is unique because it aligns with the direction of liquidity
As we mentioned before, a strong positive correlation does not guarantee that two variables will always move in the same direction over time. This is especially true when an asset (like Bitcoin) is more volatile and may temporarily deviate from its long-term correlation with a less volatile indicator (like global M2). This is why combining these two aspects (magnitude and direction) can provide a more complete picture of how Bitcoin and global M2 affect each other over time.
By looking at the directional consistency of correlations, we can get a better idea of how reliable their correlations are. This is especially true for those interested in long-term trends. If you know that Bitcoin tends to track the direction of global liquidity most of the time, you can be more confident in predicting Bitcoin's future price direction based on changes in liquidity conditions. Bitcoin has the highest correlation with the direction of global liquidity among all the assets analyzed.
The chart below further illustrates Bitcoin’s directionality in line with global liquidity over a rolling 12-month period compared to other asset classes.
This suggests that while the strength of the correlation may vary depending on the time frame, Bitcoin’s price direction is generally aligned with the direction of global liquidity. Furthermore, its price direction is closer to global liquidity than any other traditional asset analyzed.
The relationship between Bitcoin and global liquidity is not only strong in magnitude, but also consistent in direction. The data further supports the view that Bitcoin is more sensitive to liquidity conditions than other traditional assets, especially over longer time frames.
For investors, this means that global liquidity may be a key driver of Bitcoin's long-term price performance and should be considered when evaluating Bitcoin market cycles and predicting future price movements. For traders, this means that Bitcoin provides a highly sensitive investment tool that reflects the perception of global liquidity, making it the preferred reference for those who have a strong belief in liquidity.
The flaws of Bitcoin’s correlation with liquidity
While Bitcoin has a strong correlation with global liquidity in general, the results show that over shorter rolling periods, Bitcoin prices tend to deviate from liquidity trends. These deviations may be caused by internal market dynamics having a greater impact than global liquidity conditions at certain points in the Bitcoin market cycle, or by special events unique to the Bitcoin industry.
Special events are events within the cryptocurrency industry that cause a rapid shift in market sentiment or trigger large-scale liquidations. For example, a large corporate bankruptcy, an exchange hack, a regulatory crackdown, or the collapse of a Ponzi scheme.
Looking back at past instances of weakening 12-month rolling correlations between Bitcoin and global liquidity, it is clear that Bitcoin’s price tends to decouple from global liquidity trends during major industry events.
The chart below illustrates how Bitcoin’s correlation with liquidity decouples during major industry events.
The panic and selling pressure caused by key events such as the collapse of Mt. Gox, the collapse of the PlusToken Ponzi scheme, and the cryptocurrency confidence crisis caused by the Terra/Luna collapse were largely disconnected from global liquidity trends.
The 2020 COVID-19 market crash is another example. Bitcoin initially fell sharply amid widespread panic selling and risk aversion. However, as central banks responded with unprecedented liquidity injections, Bitcoin quickly rebounded, highlighting its sensitivity to liquidity changes. The disconnect in correlation at the time can be attributed to a sudden shift in market sentiment rather than changes in liquidity conditions.
While it is important to understand the impact of these idiosyncratic events on Bitcoin’s correlation with global liquidity, their unpredictability makes it difficult for investors to act. That being said, as the Bitcoin ecosystem matures, infrastructure improves, and regulation becomes clearer, I expect the frequency of these “black swan” events to decrease over time.
How the Supply Side Affects Bitcoin’s Liquidity Relevance
In addition to special events, another notable phenomenon in periods when Bitcoin's correlation with liquidity weakened is that these situations often coincide with times when Bitcoin's price reached extreme valuations and then fell sharply. This was evident at the peak of the bull markets in 2013, 2017, and 2021, when Bitcoin's correlation with liquidity decoupled as its price fell sharply from its highs.
While liquidity primarily affects the demand side of the equation, understanding distribution patterns on the supply side can also help identify periods when Bitcoin may deviate from its long-term correlation with global liquidity.
The main source of supply is old holders who profit as the price of Bitcoin rises. New issuance of block rewards also brings supply to the market, but the supply is much smaller and will only continue to decrease with each halving event. During bull markets, old holders usually cut their positions and sell to new buyers until demand is saturated. This saturation point is usually the peak of the bull market.
A key metric to assess this behavior is Bitcoin 1+ Year Holding Volatility, which measures the amount of Bitcoin held by long-term holders (at least one year) as a percentage of the total circulating supply. In other words, it measures the percentage of the total available supply held by long-term investors at any given point in time.
Historically, this indicator falls during bull markets as long-term holders sell, and rises during bear markets as long-term holders buy. The chart below shows this behavior, with red circles indicating cycle peaks and green circles indicating bottoms.
This illustrates the behavior of long-term holders during Bitcoin cycles. When Bitcoin appears to be overvalued, long-term holders tend to sell to take profits, and when Bitcoin appears to be undervalued, they tend to accumulate.
The question becomes… “How do you determine when Bitcoin is undervalued or overvalued so you can better predict when supply will flood the market or be exhausted?”
Although the dataset is still relatively small, the Market Value to Realized Value Z-Score (MVRV Z-Score) has proven to be a reliable tool for identifying when Bitcoin reaches extreme valuation levels. The MVRV Z-Score is based on three components:
1) Market Value: The current market capitalization, calculated by multiplying the price of Bitcoin by the total number of Bitcoins in circulation.
2) Realized Value: The average price at which each Bitcoin or UTXO last traded on-chain multiplied by the total circulating supply — essentially the cost of holding Bitcoin.
3) Z-score: This score measures how far market values deviate from actual values, expressed as a standard deviation, and highlights periods of extreme overvaluation or undervaluation.
When the MVRV Z-score is high, it means there is a large gap between the market price and the realized price, which means that many holders are sitting on unrealized profits. This is intuitively a good thing, but it can also indicate that Bitcoin is overbought or overvalued, and it is a good time for long-term holders to sell Bitcoin and take profits.
When the MVRV Z-score is low, it means the market price is close to or below the realized price, indicating that Bitcoin is oversold or undervalued, which is a good time for investors to start accumulating.
When the 12-month rolling correlation between the MVRV Z-score and Bitcoin’s global liquidity is overlaid, a pattern begins to emerge. The 12-month rolling correlation appears to break down when the MVRV Z-score drops sharply from its all-time highs. The red rectangles indicate these time periods.
This suggests that when Bitcoin’s MVRV Z-score begins to decline from its highs and the correlation with liquidity breaks down, internal market dynamics, such as profit-taking and panic selling, may have a greater impact on Bitcoin’s price than global liquidity conditions.
At extreme valuation levels, Bitcoin’s price action tends to be driven more by market sentiment and supply-side dynamics than by global liquidity trends. This finding is valuable for traders and investors because it can help identify situations where Bitcoin deviates from its long-term correlation with global liquidity.
For example, let’s say a trader is convinced that the dollar will fall and global liquidity will rise over the next year. Based on this analysis, Bitcoin would be the best tool to prove his point because it is the purest barometer of liquidity in the market today.
However, traders should first evaluate Bitcoin's MVRV Z-score or similar valuation metrics before entering a trade. If Bitcoin's MVRV Z-score indicates overvaluation, traders should remain cautious even in a liquid environment, as internal market dynamics could override liquidity conditions and drive price corrections.
By monitoring Bitcoin's long-term correlation with global liquidity and the MVRV Z-score, investors and traders can better predict how Bitcoin prices will respond to changes in liquidity conditions. This approach enables market participants to make more informed decisions and potentially increase their odds when investing or trading Bitcoin.
in conclusion
Bitcoin's strong correlation with global liquidity makes it a macroeconomic barometer for investors and traders. Compared with other asset classes, Bitcoin's correlation with global liquidity is not only strong, but also the most consistent in direction. One can think of Bitcoin as a mirror reflecting the global money creation rate and the relative strength of the US dollar. Unlike traditional assets such as stocks, gold or bonds, Bitcoin's correlation with liquidity is the purest.
However, Bitcoin’s correlation is not perfect. Research shows that the strength of Bitcoin’s correlation decreases in the short term, while also demonstrating the importance of identifying periods when Bitcoin’s correlation with liquidity breaks down.
Bitcoin's internal market dynamics, such as special events or extreme valuation levels, can cause it to temporarily break away from the influence of global liquidity. These times are critical for investors as they often mark price adjustments or accumulation periods. Combining global liquidity analysis with on-chain metrics such as the MVRV Z-score can provide a better understanding of Bitcoin's price cycles and help identify when its price may be driven more by sentiment than liquidity trends.
Michael Saylor once famously said, “All your models are destroyed.” Bitcoin represents a paradigm shift in money itself. Therefore, no statistical model can perfectly capture the complexity of the Bitcoin phenomenon, but some models can be useful tools to guide decision making. As the old saying goes, “All models are wrong, but some are useful.”
Since the global financial crisis, central banks have distorted financial markets through unconventional policies, making liquidity the main driver of asset prices. Therefore, understanding the changes in global liquidity is critical for any investor who hopes to successfully navigate the market today. In the past, macro analyst Luke Gromen has described Bitcoin as "the last fully functional smoke alarm" due to its ability to signal changes in liquidity conditions.
When the alarm bells sound for Bitcoin, investors would be wise to listen in order to manage risk and develop strategies to take advantage of future market opportunities.
