As the world becomes increasingly digital, the way we invest and manage our money is also changing. The world of finance has seen a significant shift toward digital assets and cryptocurrencies. As the market for these new forms of currency continues to grow and evolve, many investors are left wondering how they compare to traditional investments such as stocks. Are cryptocurrency and stocks correlated? Is it wise to diversify a portfolio by investing in both?
In this article, we will take a deep dive into the relationship between cryptocurrency and stocks, exploring the similarities and differences between the two and examining the factors that drive their prices, the possible threats and rewards of investing in each, and whether diversifying a portfolio with both is a smart move.
Cryptocurrencies are digital coins or virtual currencies that use cryptographic techniques for security. They operate independently of a central bank or government and allow for peer-to-peer transactions without intermediaries like banks.
Cryptocurrencies are exchanged through a blockchain network, a decentralized digital ledger of all transactions. Transactions are recorded in blocks linked together to form a chain, hence the name "blockchain."
As a digital currency, they can be used to purchase goods and services or held as an investment. Bitcoin is the first and most widely used cryptocurrency, but thousands of other cryptocurrencies are available today, known as altcoins, with different features and use cases.
A stock, also known as a share, represents a unit of ownership in a company. When you purchase a stock, you buy a small part of that company. The value of the stock can increase or decrease depending on the company's performance. Companies can also issue new stocks or buy back their own stocks, affecting the stock price.
When a company makes a profit, it may choose to distribute some of that profit to shareholders in the form of dividends. But besides dividends, stockholders can also make money by selling the stocks at a higher price than they bought.
Stocks are typically bought and sold on stock exchanges, which are marketplaces where stocks and other securities are traded. The most well-known stock exchanges in the world include the New York Stock Exchange (NYSE) and the NASDAQ.
Regarding investing, cryptocurrency and stocks can be great options for your portfolio, but they each have their unique characteristics and serve different purposes. Let's see the core differences regarding cryptocurrency vs stocks:
Investing in stocks usually involves opening a brokerage account, which acts as an intermediary to handle the transaction and hold the stocks in the buyer's name.
Although lots of financial products have appeared on the market to make the process more accessible for people to buy or sell stocks and/or crypto, such as Robinhood (most popular in the US), eToro (most popular in Europe), or Trading212 (most used in the UK), they may not offer as many features as traditional brokerage firms.
To open an account, you will typically need to provide personal information such as your address, Social Security number, and signature, which offers some level of protection against identity theft or fraud.
On the other hand, investing in cryptocurrency offers a different experience, one that values privacy and decentralization. Cryptocurrency transactions do not require revealing personal information; the crypto assets are held in a digital wallet or on a storage device, such as a USB drive. However, this anonymity also means that the responsibility for security falls solely on the owner. One must be vigilant in keeping track of their crypto and securing it with a long and complex password. In case of a hack, there is usually little recourse to recover the stolen crypto.
Investing in both cryptocurrency and stocks can be a rollercoaster ride, as both are volatile assets, being subject to volatility and risk. The value of these assets can go up or down at any time, and it can be challenging to predict the best time to buy or sell.
When it comes to stocks, the market has a reputation for volatility, but over the long term, the broader market has managed to trend upward, with an average total return of around 10%.
Investors also have access to various sources of information, such as financial reports to make informed decisions about buying these securities. Besides, total losses for investors are rare. There is usually an explanation for the fall, whether economical or technical.
Unlike stocks, cryptocurrency is known for its extreme volatility. For example, Ethereum, one of the most popular cryptocurrencies out there, experienced significant fluctuations in value throughout 2021, starting at around $730 and reaching a high of $4,080 in May before dropping to approximately $1,786 in July and then rising again to $4,082 in October. So, these fluctuations in value can be much more dramatic and rapid compared to stocks.
In the United States, agencies such as the Securities and Exchange Commission (SEC) oversee and regulate the stock market and publicly traded companies to ensure transparency. Such agencies like the SEC exist in one form or another almost everywhere in the world. This helps investors make informed decisions.
However, cryptocurrencies are not as heavily regulated, which can be seen as a benefit by some investors who prefer less government oversight. Instead, decentralized networks run each cryptocurrency, with individuals focused on maintaining its technology and ensuring the project's integrity. However, the lack of regulation also means that the rules and regulations for cryptocurrencies can change quickly, which can be risky for investors.
The ease of buying and selling investments, whether they are stocks or cryptocurrencies, is decided by their liquidity. Stocks are considered highly liquid because many active stock market traders exist.
However, the liquidity of different types of cryptocurrency can vary. For instance, Bitcoin is considered more liquid than other cryptocurrencies, such as Cardano, because it has a higher trading volume, meaning there are more buyers and sellers. Besides, both stock and crypto holders can be affected by slippage, which occurs when a large amount of an asset is sold during a period of low liquidity, leading to losses. However, the risk of this happening is higher for crypto investors due to the lower liquidity in the crypto markets.
Stocks are traded on regulated exchanges around the world, offering investors security, stability, and transparency. These exchanges are equipped to handle high trading volumes and are subject to strict regulations to protect buyers and sellers.
On the other hand, cryptocurrency exchanges are relatively new, and many options are available, such as Binance and Coinbase, which are the most well-known crypto exchanges. Some of these exchanges facilitate the exchange of traditional currencies like the US dollar for cryptocurrency through partnerships with third parties.
However, be very careful about which crypto exchange you trust. Being an unregulated market yet, some exchanges may not be what they seem and may not really support you. For example, let's remember the case of FTX, which was until recently considered one of the best exchanges in the world and was proven to be fraudulent.
Thus, we recommend you do your own review and check a few reviews related to those exchanges before trusting them.
These are the main differences related to cryptocurrency vs. stocks but remember that they are not the only ones.
For the analysis of the stock market for 2021 and 2022, we have been guided by the S&P 500 index, the US stock market index that summarizes the top 500 most influential companies in the US. So, as you can see, in 2021, the stock market rose approximately 26.89%, marking the benchmark's third straight positive year.
This rise did not last much longer. Starting with 2022, the effects of the pandemic crisis and the massive capital pumping that the US did in that period could be seen. Thus, the S&P 500 had a challenging year, with a decline of 19.44%, making it the worst performance since 2008, which saw a drop of 38.49%.
On the other hand, related to the crypto market, we can also note that 2021 the crypto market peaked at $2.9 trillion in November 2021, marking an increase of about 283% from January to that point in the entire market. Just like 2022 in the stock market, this year came with the same repercussions for the crypto market, so in 2022, of the $2.9 trillion that the market enjoyed, by the end of 2022, it had only about $800 million left.
Cryptocurrency, like Bitcoin, started gaining attention as a potential investment option in late 2016 and early 2017, when its value began to increase. Of course, there were rises and falls between then and the pandemic.
However, with the advent of the pandemic, many investors also became more concerned about the economy and the stock market, which is why they began to diversify their portfolios even more and invest more in digital currencies. As such, it is easy to see why there has been massive growth in this market.
Also, based on the stimulus checks offered by the US to its citizens and the fear generated by the possible coming of a new financial crisis, even retail investors started to get more involved in investing, hence the rise of the stock and crypto investments.
Thus, it can be seen that even cryptocurrencies have started to be treated as stocks by traders and investors - congealing their function as an asset class.
But by 2022, the value of Bitcoin and other crypto assets began to decrease, the same as the stock market, and the following months were also tough for both markets. So, it is obvious, and we can see that there is some connection between the crypto and stock markets, with changes in one market often impacting the other.
There are some differences between crypto assets and equities, the most essential being ownership, volatility, regulation, liquidity, and exchanges.
However, about cryptocurrency vs. stocks, a similar trend can be seen about the rise or fall in their prices. This trend has also appeared as a result of investors tending to have better portfolio management, with more diversified assets, considering that a stock portfolio is not always the best option and there is a lot of potential concerning digital assets.
If you want to buy crypto, be aware that it is advisable to consult a professional financial advisor with expertise in cryptocurrencies before putting your money at risk.