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The Correlation Between Bitcoin (BTC) and DXY: An Analysis

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Bitcoin and DXY Correlation

Here we go again.

Bitcoin—and indeed, most crypto prices, are at record levels. The almighty dollar, on the other hand, is faring rather well. It is obviously sluggish but relatively steady against other major currencies, including the Euro and the GBP.

Earlier on, the DXY – an index that tracks the performance of the USD, wasn’t closely watched by trackers not until when institutional money began pouring into crypto and Bitcoin. Often, these rich traders used the USD. Therefore, it only makes sense how the DXY – the USD, performs in relation to the BTC.

Note that, the more there is money flowing in from institutions to BTC, the more there will be a correlation.

The “type” of this correlation is what keeps analysts awake.

Presently, the push and pull between fiat supporters and Bitcoin diehards means that the tough questions should be asked: Which currency follows which?

Is the USD ahead and Bitcoin trailing? What is their correlation?

Spoiler alert: the USD came first and Bitcoin later. Then, 13 years after formation, we have a robust, autonomous, private system threatening to disrupt everything about traditional finance.
Regulators are closely monitoring this development while more retailers—the broader populace, are ecstatic. Finally, money!

First, What is Money?

To understand how this works, we must first have a clear definition of what makes money. The FED and other central banks across the world—except Panama, says their fiat currencies are legal tender.

That is money.

They can be used as a medium of exchange and are backed not by gold.

Only by the prerogative of their sovereignty.

The bad news here is that countries vary in their sovereignty (read economic strength). Accordingly, their economic muscle matters and this explains the existence of the multi-trillion volume a day FX market—a topic for another day.

If the FED—since we are talking about the USD, asserts that its paper creation works perfectly as money—again, who can challenge it? Every central bank follows this model.

In this, they claim each USD in circulation can be used as a medium of exchange. Additionally, the greenback serves as a unit of account, a store of value, and a standard of deferred payment.
A level deeper and outside of the basic functions of money, each USD is divisible, portable, acceptable, durable, fungible, and has limited supply.

Well, from here, there are several arguments.

Compared to Bitcoin, the tables appear to be turning, but the FED and bankers, in general, argue otherwise. In their defense, they say Bitcoin is not “sound” money. That is, while it can store value and be used as a medium of exchange, its high volatility makes it a poor unit of account.

Here is a counter-argument: Bitcoin’s volatility has been falling with increasing adoption. Yes, in the early days, there was a problem with volatility—even most fiat currencies face the same, but that is changing. In fact, BTC’s volatility is lower than some G-7’s currencies if the lens is zoomed in closer.

Over and above all this, Bitcoin is super portable, durable, and divisible. Admittedly, it is also hard to pin down. Most hold the coin for speculation—just like stocks, some bet on its technology—think of growth stocks, while others actually use it to pay for services—just like cash.

For Bitcoin’s threat to “sovereignty,” measured by the strength of a country’s fiat currency and its ability to control the money supply, Bitcoin isn’t accepted as legal tender. This status is despite Bitcoin’s fixed supply. Understandably, this will destroy fiat if that becomes the case.

Bitcoin Versus the USD

US-dollars-notes

Instead, because of existing laws and to avoid violating the constitution—especially in democratic countries, BTC is considered a commodity.
However, some firms – read Tesla, are now accepting BTC as a means of payment. That is, less than 12 years after formation, Bitcoin is now a “standard of deferred payment,” just like the greenback.

You must be keen now.

From a trader’s point of view, why does this matter?

Here’s why.

Both the USD and BTC are open for trading, meaning traders can capitalize on correlation out-of-sync moments to profit from possible arbitrage.

USD and fiat have the lead in its market broadness and depth, with the FX market transacting over $5 trillion a day being a testament.

On the other side, BTC is available for trading but it is mostly unregulated. Still, this doesn’t prevent participation. After the suppression, Bitcoin is now being accepted. This trend has subsequently boosted its market cap above $1.1 trillion.

As above, BTC and USD, with nuanced differences—especially in regulation and market depth, are liquid assets with different forms of application and trading frameworks being applied.

Both are attractive, act as a store-of-value, and serve various functions depending on holders’ needs.

What is DXY? Why Bitcoin Traders and Investors Track This Index

What we do know is that there exists a correlation between Bitcoin and the S&P 500 index. By early Q3 2020, their correlation reached a high of 0.38—pretty impressive.

Focus now is on the BTC—DXY.

Even as we search for answers, we should know that correlation relies on price movement. And when there is hysteria and juiced up by sentiment, prices and correlations don’t make much sense.

Now, how are they correlated? Is their linkup positive or inverse?

To understand this, we must look at the performance of the DXY—or the DXY, versus Bitcoin (BTC).

The DXY is an index that measures the strength of the USD against a basket of six other global currencies: EURO, GBP, CHF, YEN, CAD, and SEK. These currencies are weighted, and therefore, the Euro has a larger share given its significance in global trade.

To explain, the DXY index goes up when the USD strengthens, gaining in value, especially versus the Euro—or any other currency depending on the weighting.

However, how the DXY fluctuates depends on an array of factors. Ideally, in an efficient market, the value of the DXY will haphazardly move up and down due to market forces mostly streaming in from the U.S. since, well, it measures how the USD is performing against the other six major currencies as aforementioned.

These forces are dependent on several economic factors like labor conditions, central bank or monetary policy decisions, inflation, and more, just to name a few. Each country whose currency is listed on the basket has different fundamentals and priorities, especially now with the coronavirus pandemic.

If anything, the DXY is a strong, helpful economic indicator. Therefore, when the DXY rises, global markets tend to pull back because of one thing: the USD is a global reserve currency and is used to price many assets, including gold and Bitcoin—both of which are considered commodities.

On the other hand, Bitcoin is successful because of various factors. Laws continued to be formulated that helped with the coin’s adoption.

With more use, it is evident that crypto and Bitcoin as an alternative currency and financial system will succeed, a boost for prices.

Is There a Correlation Between Bitcoin and the DXY (USD)?

So, how are the DXY and BTC correlated?

Let’s look at charts, between Apr 2020 and 2021:

BTC/USD chart:

Bitcoin up dxy correlation chart

DXY YTD:

Bitcoin DXY correlation chart dollar down

Placing them on the same chart, and this is what we have:

Here, it is pretty hard to determine how Bitcoin correlates with the greenback.

However, there could be a weak inverse link that’s not fully developed.

And the same trend can be seen with BTC versus common fiat currencies like the Euro, Yen, or even the GBP.

Obviously, more data is required for a clear relationship to be hashed out between Bitcoin and the DXY.

But what’s there to be seen is that there exists a form of negative correlation (welcomed) since Bitcoin and gold are under the same asset class, watched closely by market participants.

While not all exchanges price their BTC in USD—but rather USDT, serving the same purpose, there is no doubt that the price of BTC is tracked in USD—not Euro, Yen, or even GBP.

Presently—and interestingly, Bitcoin peak highs are accompanied by DXY prices at their cycle lows. While the DXY has been showing strength, Bitcoin bulls are also stepping up, albeit with lower intensity than before.

Why Bitcoin—DXY Might Have a Negative Correlation

There is a reason why early indicators suggest a negative correlation between the price of Bitcoin and the DXY.

That means if the USD rises–(that is, the DXY rising), the odds of the BTC crashing are high and vice versa.

As the Winklevoss Twins put it, the mismanagement of the FED and monetary policy creates an environment where the correlation between the price of BTC and DXY will be aggressively negative.

Moreover, an inverse correlation between BTC and the DXY could hint at the digital asset not being uniformly represented in traditional portfolios. And it is clear, a paltry $59 billion is held by public companies.

Here’s how:
One, there is little doubt that Bitcoin is considered an alternative to gold. FED officials even say Bitcoin can replace gold–but yes—not the USD—which is funny because gold has outlived fiat every other time. With Bitcoin in the picture and the massive outflows from gold ETFs to the digital asset, the scales tip toward Bitcoin, which behaves like gold.

Second, central banks’ action and money printing leading to inflation—at least worries for it, swings the discussion back to precious metals known for their value-preserving properties. Money printing and the effects of the Coronavirus pandemic shredded the U.S.’s economy. Interestingly, in late Dec and early Q1 2020, USD strengthened on it being a safe haven. However, subsequent interventions and needless money printing saw the USD and DXY crater. A plunging DXY fed into Bitcoin—which soared to present valuations—and alternative “safe havens.” Therefore, before BTC’s market cap ($1.1 trillion) catches up with gold’s ($7 trillion), both store-of-value assets would most likely rise on a weaker USD.

Third, it is worth not forgetting that crypto is a risk-on asset. Being risk-on means the comfort of users flocking to relatively volatile and riskier assets in search of better yields. If memory serves us well, it is exactly the same environment that FED created in 2020 with their helicopter money through stimulus. With investors cautious due to uncertainties, risk-on assets often crash. A prime example is what happened with BTC and crypto prices on Mar 12 when prices crashed in a risk-off environment, causing an outflow to cash (USD).

Fourth, the case of when the global markets are running hot. By early Q2 2021, there were hints of over-valuation in crypto circles and the stock markets. Herein, it is expected that if there are steep corrections, traders will cash out in USD—not BTC, causing the DXY to strengthen.

Why the DXY-BTC Correlation Matters to Traders

man-trading-bitcoin

We may talk of the whys at length, but overly, regardless of the DXY-BTC correlation, it is incredibly important that traders – both retailers and institutions, keep track of this relationship.
For simple reasons: The USD is not going anywhere anytime soon. It would dominate trading being a reserve currency and digital assets, including Bitcoin–offered by exchanges like the CME regulated by the CFTC, will continue pricing the coin in the USD, not Yen/Euro.

Keeping tabs of this correlation comes at the fore, especially now. More institutions, regulated by the U.S and therefore making payments in the USD, are pouring into crypto. Watching how the DXY performs would be key in advising trading decisions. Fittingly, it would be key for institutions, tracking long-term DXY-BTC correlation, to adjust their portfolios.

But, outside of the DXY-BTC simplification of buying BTC when DXY falls, and vice versa, caution should hold especially for swing and hodlers.

At the same time, traders should know that the DXY-BTC correlation may sometimes not hold, failing to respond to common sense. After all, all correlations are based on price movements which in turn can be influenced by the sentiment that affects momentum.

And as we know, sentiment can untether prices that may diverge from holding fundamentals. Sometimes, when BTC prices are rallying, the USD may be equally strong. In this case, the correlation won’t hold as emotions flow and FOMO dominates.

Bitcoin to $100k on a Weaker USD?

Still, based on the above DXY-BTC relationships, there could be opportunities for swing traders to take advantage of this correlation to pick profits from temporary misalignment.

However, it will be quite challenging for traders with larger capital outlays who may have to adopt different strategies to capitalize on the BTC—DXY correlation.

But, if the pandemic and the current healthcare crisis continues, the U.S government will be forced to borrow more and devalue its currency. A weaker USD (falling DXY) will instead spark a migration to alternative safe havens of which Bitcoin tops the chart.

Accordingly, if this trend continues, it won’t be a surprise for Bitcoin to tap on a falling USD to reach six figures.

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