Institutional investors were warming to Bitcoin just as the pandemic struck. Now the main reason they found cryptocurrencies appealing no longer appears justified.

Nearly four out of five institutional investors said they find something to like about digital assets such as Bitcoin, according to the results of a new survey by brokerage firm Fidelity. The foremost reason, as reported by 36% of respondents, was that they believed cryptocurrencies were “uncorrelated to other assets,” like stocks.

But the economic devastation of the recent coronavirus pandemic has seemingly shattered that investment thesis. The wave of destruction has exposed entanglements between digital currencies and the stock market that undermine the very reason investors said they were most interested.

A secret romance

In mid-March the markets crashed. The S&P 500, a common stock market measure, plummeted 14% between March 10 to 12, as did Bitcoin, which lost about 38% of its market value on March 12 alone.

The selloff revealed that stock and cryptocurrency values are at least partly linked, rather than being independent of one another. In April, a study by Binance, the world’s largest cryptocurrency exchange, found the correlation of Bitcoin's price to the performance of the S&P 500 was “relatively high” at 57% for the first quarter. The correlation was even higher, 64%, when comparing Bitcoin to the Russell 2000, another stock market index that features smaller-cap stocks.

While Bitcoin boosters may have considered the unexpected ties between Bitcoin and the stock market to be a fluke—the relationship "remains very unlikely to persist” in the months ahead, the Binance report's author wagered—recent market movements suggest otherwise.

Since April, Bitcoin and the stock market have moved closer in lockstep. As the following chart from Coin Metrics, a cryptocurrency data firm, shows, the correlation has trended upward from “zero” in March, when the Fidelity study ended, to more than 0.2 last month. (On the vertical axis: “0” means uncorrelated, "1" means correlated.)

The correlation may be getting stronger. On June 11, after Fed chair Jerome Powell gave his dour assessment of the global economic outlook, investors reacted negatively, causing the stock market’s biggest selloff since March. The S&P 500 dropped 5.7%, and Bitcoin—which had gained 30% for the year, despite its March turmoil—dipped 6.4% to $9,100.

The coincidences between Bitcoin and the stock market's ups and downs reveal a hard truth.

The anti-Midas touch

As investment firms—which hold great sway in traditional asset markets—have extended their influence to digital currencies, their gyrations now reverberate beyond the stock market and into cryptoland.

Established institutional investors tend to hold larger positions in the stock market. Sometimes, when volatility strikes, they're hit with margin calls, requirements by brokerages for more cash deposits to cover possible losses.

In practice, this means institutional investors may be forced quickly to liquidate positions elsewhere. It can lead to Bitcoin, among other holdings, getting jettisoned.

These circumstances are pushing the two formerly disparate realms more in sync. It's a self-defeating cycle. The very reason professional investors have taken a liking to Bitcoin—a supposed lack of correlation to other assets, like stocks—is justifying its addition to more portfolios, thereby reducing its independence from other assets.

The consequence of these strengthened ties is paradoxical. It’s as though collectors, valuing the worth of treasures by their shininess, ruined relics simply through the frequency of their touching them, smudging surfaces and causing the objects to lose their luster.

Ria Bhutoria, director of research at Fidelity Digital Assets, Fidelity’s two-year-old cryptocurrency-oriented business, says this greater correlation between digital assets and the stock market could be temporary. “There are brief periods of correlation during turbulence and uncertainty,” she says. But over the long run, she adds, there’s reason to believe, based on past experience, that the correlation could “end up trending back down over time.”

Only time will tell how investors will treat Bitcoin in the event that economic conditions worsen. The Fidelity team is watching closely what may happen, Bhutoria says, in a "prolonged risk off period," referring to a situation in which investors off-load riskier assets, like high-yield “junk” bonds, and head for assets considered safer, like U.S. Treasuries.

That is, will investors treat Bitcoin as a life jacket, a refuge to preserve people's wealth, or will they treat it as flotsam?

All that glitters is not gold

The two other top reasons institutional investors said they liked digital assets were purely speculative.

About a third of respondents to the Fidelity survey, which included interviews with 800 U.S. and European institutional investors between November and March, said they liked digital assets such as Bitcoin because they “consider it an innovative technology play.” Another third, 33%, said they liked it because it had “high potential upside.”

These traits—a fancy tech angle and the possibility of a get-rich-quick opportunity—represent the antithesis of the philosophy of the world's most famous value investors. Warren Buffett, chief among them, has likened Bitcoin to "rat poison squared."

An affinity for Bitcoin is perhaps more suited to the mentality of high-risk, venture capital investing. But since central banks around the world have adopted near-zero—and in some cases negative—interest rates, many investors find themselves in search of yield elsewhere, including in riskier assets, such as cryptocurrencies.

Some investors worry that a Fed bent on printing money to stave off financial calamity could result in higher inflation down the line. A portion of these investors believe Bitcoin could serve as “digital gold,” like the real-world yellow stuff, a possible hedge against inflation.

Yet, ironically, one asset to which so-called digital gold appeared least correlated in the first quarter was…gold. Another chart provided by Coin Metrics reveals the increasingly untethered relationship between Bitcoin and gold in recent months.

While the circumstances of the market today may be ephemeral and anomalous, they call into question beliefs held by many professional investors and cryptocurrency believers. At least today, people's most common assumptions appear to jar against reality.

As the dust kicked up in the wreckage of the pandemic settles, investors may have to rethink what they find appealing about Bitcoin.