By Sam Callahan, Lyn Alden
Compiled by: Block unicorn
summary
In any given 12-month period, Bitcoin’s direction of movement is aligned with global liquidity 83% of the time, a higher rate than any other major asset class, making it a powerful indicator of liquidity conditions.
Bitcoin has a high correlation with global liquidity, but is not immune to short-term deviations caused by special events or internal market dynamics, especially during periods of extreme valuations.
Combining global liquidity conditions with Bitcoin on-chain valuation metrics provides a more nuanced view of Bitcoin cycles, helping investors identify moments when internal market dynamics may temporarily decouple Bitcoin from liquidity trends.
introduction
Understanding how asset prices change with changes in global liquidity has become critical for investors who want to increase returns and effectively manage risk. 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 been particularly evident since the Global Financial Crisis (GFC). Since then, these unconventional monetary policies have increasingly become the dominant force driving asset prices. Central bankers have used liquidity levers to turn markets into one big trade, and as economist Mohamed El-Elrian puts it, central banks have become “the only game in town.”
Stanley Druckenmiller echoed the sentiment, saying, “Earnings don’t move the market, it’s the Federal Reserve Board…watch the central bank and watch what happens with liquidity…most people in the market are looking at earnings and the regular indicators. Liquidity is what moves the market.”
This is particularly evident when we examine how closely the S&P 500 has tracked global liquidity since the GFC.
The interpretation of the above chart comes down to simple supply and demand. If there is more money 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 becomes critical for investors to understand how to measure global liquidity and how different assets react 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, but for this analysis 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 consumption, investment, and borrowing around the world. Another way to think of 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 matters because the dollar is the global reserve currency and therefore the primary unit of account for global trade, global contracts, and global debt. When the dollar is stronger, countries' debts become stronger. When the dollar is weaker, countries' debts become weaker. Global broad money denominated in dollars is like a great measure of world liquidity. How fast are fiat currency units being created? How strong is the dollar 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.
While there are other ways to measure global liquidity (such as considering short-term government debt or global foreign exchange swaps markets), for the rest of this article, when you read “global liquidity”, please understand it as “global M2”.
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 tends to suffer. This dynamic has led some to call Bitcoin a "liquidity vane."
The chart below clearly shows how the Bitcoin price tracks changes in global liquidity.
Likewise, comparing the year-over-year percentage changes in Bitcoin and global liquidity also highlights that the two appear to move in tandem, with Bitcoin’s price rising when liquidity increases and falling when liquidity decreases.
As can be seen in the above chart, Bitcoin’s price appears to be highly sensitive to changes in global liquidity. But is it the most sensitive asset in the market today?
Generally speaking, risky assets are more correlated with liquidity conditions. In a good liquidity environment, investors tend to adopt a risk-on strategy and move capital to assets that are considered high risk and high return. Conversely, when liquidity tightens, investors usually move capital to assets they consider safer. This explains why assets such as stocks usually perform well in an environment of rising liquidity.
However, stock prices are also affected by other confounding factors that are unrelated to liquidity conditions. For example, stock performance is partly driven by factors such as earnings and dividends, so their prices are also linked to economic performance. This may have a negative impact on the pure correlation of stocks with global liquidity.
Additionally, the U.S. stock market benefits from passive inflows from retirement accounts such as 401(k)s, which further impacts its performance regardless of liquidity conditions. These passive inflows may buffer the U.S. stock market during times of volatility in liquidity conditions, potentially reducing its sensitivity to global liquidity conditions.
Gold's relationship with liquidity is more complex. On the one hand, gold benefits from rising 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-averse behavior, demand for gold may increase as investors seek safety. This means that even if liquidity is drained from the system, the price of gold can hold up 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.
This brings us back to Bitcoin. Unlike stocks, Bitcoin has no earnings or dividends, and no structural buying that affects its performance. Unlike gold and bonds, at this stage in Bitcoin's adoption cycle, most capital pools still view it as a risk asset. This makes Bitcoin perhaps the purest correlation with global liquidity relative to other assets.
If this holds true, then this is a valuable insight 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 insights on how investors can use this information to their advantage 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 strength and direction of the relationship.
The strength of the correlation reveals the degree of association between the two variables. The higher the correlation, the more predictable the impact of changes in global M2 on Bitcoin prices, both in the same direction and in the opposite direction. Understanding this degree of association is key to measuring Bitcoin's sensitivity to changes in global liquidity.
Bitcoin’s strong sensitivity to liquidity is evident when analyzing 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 rolling 12-month correlation, Bitcoin’s average correlation with global liquidity dropped to 0.51. This is still a moderately positive relationship, but significantly lower than the overall correlation.
This suggests that Bitcoin’s price is not that closely tied to annual changes in liquidity. Furthermore, when examining the 6-month rolling correlation, the correlation drops further to 0.36.
This suggests that Bitcoin’s price deviates increasingly from its long-term liquidity trend as the time frame shortens, suggesting that short-term price movements are more likely to be influenced by Bitcoin-specific 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 Global Equity ETF (VT), iShares MSCI Emerging Markets ETF (EEM), iShares 20+ Year Treasury Bond ETF (TLT), Vanguard Total Bond Market ETF (BND), and gold.
Bitcoin has the highest average correlation with global liquidity over a rolling 12-month period, followed closely by gold. Equity indices are next in line, while, as expected, bond indices have the lowest correlation with liquidity.
When analyzing the correlation between assets and global liquidity by year-over-year percentage change, 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 highlights 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 rolling 12-month period; 3) Bitcoin's correlation with global liquidity weakens as the time frame shortens.
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 (such as Bitcoin) is volatile and may temporarily deviate from its long-term relationship with a less volatile indicator (such as global M2). This is why combining the two aspects - strength and direction - can provide a more complete picture of the interaction between Bitcoin and global M2.
By examining the directional consistency of this relationship, we can better understand the reliability of their correlation. This is especially important 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 more confidently predict its future price direction based on changes in liquidity conditions.
In terms of directional consistency, Bitcoin has the highest correlation with the direction of global liquidity among all assets analyzed. In 12-month cycles, Bitcoin moves in the same direction as global liquidity 83% of the time, and in 6-month cycles 74%, highlighting the consistency of the directional relationship.
The chart below further illustrates Bitcoin’s directional alignment with global liquidity over a 12-month period compared to other asset classes.
These findings are noteworthy because they show 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. Moreover, its price direction is closer to global liquidity than any other traditional asset analyzed.
This analysis shows that 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 can express a view on global liquidity, making it a top choice for investors who have a strong belief in liquidity.
Identifying Breaking Points in Bitcoin’s Long-Term Liquidity Relationship
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 they may be driven by incidental events unique to the Bitcoin industry.
Episodes are events within the cryptocurrency industry that can cause a rapid shift in market sentiment or trigger large-scale liquidations. Examples include large corporate bankruptcies, exchange hacks, regulatory developments, or the collapse of a Ponzi scheme.
Looking back at historical instances of weakening 12-month rolling correlations between Bitcoin and global liquidity, it is clear that Bitcoin’s price tends to decouple from liquidity trends around major industry events.
The chart below shows how Bitcoin’s correlation with liquidity breaks down around these major events.
The panic and selling pressure triggered by key events such as the collapse of Mt. Gox, the collapse of the PlusToken Ponzi scheme, and the crypto credit crisis caused by the Terra/Luna collapse and the bankruptcy of several crypto lenders were largely disconnected from global liquidity trends.
The 2020 COVID-19 market crash provides 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 collapse of 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 sporadic 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 supply-side dynamics affect Bitcoin’s liquidity relevance
Aside from sporadic events, another notable pattern in periods where Bitcoin’s correlation with liquidity has 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 runs 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 available for sale is old holders who profit as the price of Bitcoin rises. New issuance of block rewards also adds supply to the market, but in much smaller quantities and only continues to decrease with each halving event. During bull markets, old holders typically cut their positions and sell to new buyers until demand is saturated. At this saturation moment, the peak of the bull market usually occurs.
A key metric to assess this behavior is the Bitcoin 1+ Year HODL Wave chart, which measures the amount of Bitcoin held by long-term holders (at least one year) as a percentage of the total circulating supply. Basically, 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 more. The chart below highlights 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 take profits, and when Bitcoin appears to be undervalued, they tend to accumulate.
Now the question becomes… “How do you determine when Bitcoin is undervalued or overvalued so you can better predict when supply will flood or drain from the market?”
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 cap, calculated by multiplying the price of Bitcoin by the total number of Bitcoins in circulation.
2.) Realized value — the average price of each Bitcoin or unspent transaction output (UTXO) when it last transacted on-chain, multiplied by the total circulating supply — is essentially the on-chain cost basis for Bitcoin holders.
3.) Z-score – measures how far market value deviates from actual value, expressed as a standard deviation, highlighting 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 - 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 actual price, indicating that Bitcoin is oversold or undervalued — a good time for investors to start accumulating.
When the MVRV Z-score is overlaid with the 12-month rolling correlation between Bitcoin and global liquidity, a pattern begins to emerge. When the MVRV Z-score drops sharply from its all-time highs, the 12-month rolling correlation appears to break down. The red rectangle below highlights 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 is often driven more by market sentiment and supply-side dynamics than by global liquidity trends. This insight is valuable for traders and investors because it can help identify rare instances when 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 vehicle to express his view because it is the purest indicator of liquidity in the market today.
However, these findings suggest that traders should first assess 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 its 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 of a successful outcome when investing or trading Bitcoin.
in conclusion
Bitcoin's strong correlation with global liquidity makes it a valuable macroeconomic bellwether for investors and traders. Compared to other asset classes, Bitcoin's correlation is not only strong, but also has the highest degree of directional consistency with global liquidity conditions. One can think of Bitcoin as a mirror reflecting the rate of global money creation and the relative strength of the US dollar. Unlike traditional assets such as stocks, gold or bonds, Bitcoin's correlation with liquidity remains relatively pure.
However, Bitcoin’s correlation is not perfect. These findings suggest that the strength of Bitcoin’s correlation decreases over shorter time periods, and also demonstrate the importance of identifying periods when Bitcoin’s correlation with liquidity tends to break down.
Internal market dynamics, such as episodic events or extreme valuation levels, can cause Bitcoin to temporarily deviate from global liquidity conditions. These times are critical for investors as they often mark price corrections or accumulation periods. Combining global liquidity analysis with on-chain metrics such as the MVRV Z-score provides a better understanding of Bitcoin’s price cycles and helps identify when its price may be driven more by sentiment than broader global 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, even if they are imperfect. 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 primary driver of asset prices. Therefore, understanding the dynamics of global liquidity is critical for any investor who hopes to successfully navigate the markets 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, and this analysis supports this statement.
When the alarm bells sound for Bitcoin, investors would be wise to listen in order to manage risk and position themselves appropriately to seize future market opportunities.
appendix
An interesting finding from this analysis is that international equity ETFs such as EEM and VT have a weaker correlation with global liquidity than the S&P 500. Traditionally, investors have expressed their views on global liquidity through emerging market stocks. There are a number of reasons for this:
1.) Emerging market stocks are generally riskier than developed market stocks. As such, they are widely believed to be more sensitive to changes in global liquidity conditions.
2.) Emerging market stocks do not have the same structural buying from retirement accounts as U.S. stocks, which could distort their relationship to global liquidity.
3.) Emerging markets are heavily dependent on foreign financing. According to the Bank for International Settlements, emerging market economies currently hold trillions of dollars worth of dollar-denominated debt. This makes them more sensitive to changes in global liquidity because when liquidity tightens and the dollar strengthens, it becomes more expensive for these countries to repay their dollar-denominated debt. In addition to the increased repayment costs, it will also be more expensive for them to continue borrowing in the future.
During the period when these correlations were analyzed, the U.S. dollar was in a strong dollar cycle, which put pressure on emerging market economies and affected the entire data set.
As a result, the S&P 500 has outperformed the EEM over the past decade, reflecting the challenges that emerging markets face in a strong dollar environment.
Looking at the two charts side by side, it is clear to see that there have been multiple divergences in price action between SPY and EEM over this time frame, with SPY rising while EEM fell or moved sideways.
The chart below highlights the divergence between SPY and EEM at different points in time, showing that when SPY was rising, EEM was falling or moving sideways.
This divergence explains why the correlation of the EEM with global liquidity may not be as strong as readers might expect during this period. It would be a useful exercise to conduct this analysis over a longer timeframe, including the entire EM cycle, where we would examine the correlation of the EEM with global liquidity during both strong and weak dollar cycles.
Similar to Bitcoin, EEMs are subject to specific risks that could temporarily disrupt their long-term correlation with global liquidity. Unusual events in emerging market economies could temporarily disrupt their correlation with global liquidity trends. These unusual events can be specific to a country or region and include political instability, geopolitical risks, natural disasters, currency devaluations, foreign capital flight, local regulatory developments, and financial/economic crises.
Investors and traders need to be aware of these risks before attempting to use EEMs to express views on global liquidity. The analysis shows that Bitcoin is more strongly correlated, but also moves in line with global liquidity more frequently than EEM. In addition, Bitcoin has several advantages: It is a decentralized asset that is not directly affected by regional economic instability and is therefore less susceptible to idiosyncratic local events. Bitcoin is also a global asset, reducing the impact of country-specific events and regulatory changes. This makes it a more consistent indicator of global liquidity than the EEM, which can be significantly affected by emerging market-specific issues. Therefore, Bitcoin provides a tool that more purely reflects global liquidity trends.
