Why Bitcoin, Ethereum Lead Stock Markets Lower

The stock market reacted negatively last week to fears of higher interest rates and a slowing economy, and it didn’t look like the new week was going to start any differently. As of 8:45 a.m. ET, futures contracts on Dow Jones Industrial Average (^DJI 0.00%), S&P 500 (^GSPC -0.72%)and Nasdaq Composite (^IXIC 0.00%) had declined another 1%, adding to significant declines of about 4% to 5% last week.

The cryptocurrency markets have not helped investors much lately, with prices on Bitcoin (BTC -5.57%), Ethereum (ETH -7.90%), and other well-known digital assets that do not provide any ballast for diversified portfolios. In fact, the losses for Bitcoin and Ethereum on Monday morning were even more extensive than for the stock market. That has some investors wondering whether the long-term promise of cryptocurrencies as a game-changing financial innovation will be able to survive a negative cycle of tighter monetary policy and higher interest rates.

Another hit to crypto confidence

Crypto markets are open all weekend, but most of the decline in digital assets didn’t come until early Monday morning. After trading either side of $20,000 on Saturday and Sunday, Bitcoin fell as much as $1,600 early Monday, and shortly before the stock market opened, the digital asset was trading at $18,800.

Ethereum had a bit more trouble holding its ground over the weekend, as the price began to slide on Sunday. From the level around $1,450 on Friday afternoon, Ethereum lost almost 10% of its value, trading at $1,320 just before the market opened. Although Ethereum has its own fundamental changes underway as a result of the recently completed Merge event, some of the same macroeconomic factors are affecting both cryptocurrency giants.

Other popular tokens also lost ground. Both useful cryptos like Cardano and Polygon and more meme-like digital assets such as Shiba Inu and Dogecoin was down 6% to 8% or so Monday morning.

Even crypto investors are watching the Fed

Most market participants believe that the same concerns that have hit the stock market are also driving cryptocurrency markets lower. Indeed, it is possible that the two markets are part of a wider feedback loop where weakness in one market creates further concern for the other.

Digital asset projects have a lot in common with some of the more speculative stocks in the tech space, especially among fintech companies. New cryptocurrency projects have attracted significant amounts of venture capital and seed funding from private sources, and this money was so readily available in part because low interest rates made it easy for investors to access capital.

Now, crypto investing and high-growth stocks share many of the same potential roadblocks. As the cost of capital increases, it will become increasingly important for companies to be able to generate their own positive cash flow to avoid having to go to increasingly stingy capital markets to raise money. Those who can do so will have an enormous competitive advantage over those who have to hunt for capital on far less attractive terms than they have received in recent years.

Equity investors have seen those concerns emerge in the larger declines in the more speculative corner of the high-growth equity universe. Crypto investors see it in the price behavior of lesser-known digital assets. Yet just as the tech giants like apple and Amazon have not been immune to the bear market in stocks, so too have Bitcoin and Ethereum been vulnerable to the same macroeconomic challenges that smaller digital asset projects face.

What monetary policy can do to crypto

If the Fed remains very aggressive in raising interest rates to curb inflation, it could confirm the bearish argument in cryptocurrency markets as well. That could prolong the current crypto winter for a while longer and force innovators in the space to focus on their most profitable ideas to survive.