Global Market Liquidity and Its Impact on Crypto Assets
“Liquidity” does not refer to the ease of trading cryptocurrencies such as Bitcoin (BTC) or Chia (XCH) on exchanges without affecting their prices. Rather, it pertains to global market liquidity, which encompasses the total amount of money and credit available in the global economy. This includes factors such as central bank policies, interest rates, the money supply, and the accessibility of financing for businesses and individuals. Global liquidity significantly influences the behavior of crypto assets. In the following sections, I will elucidate its effects on BTC and XCH and explain why a direct comparison between them is inappropriate without accounting for their distinct characteristics.
What is Global Market Liquidity?
Global market liquidity quantifies the availability of “financial fuel” within the economic system. When central banks reduce interest rates or implement measures such as quantitative easing (QE) to inject money into the economy, liquidity expands. This facilitates easier access to credit and promotes investment in riskier assets, including cryptocurrencies. Conversely, when liquidity contracts—due to factors like increased interest rates or more stringent monetary policies—credit availability diminishes, prompting investors to retreat from speculative assets.
Quantifying liquidity is a complex endeavor. Many rely on M2, which includes cash in circulation, deposits readily convertible into cash, money market funds, and similar instruments. For this analysis, I have employed the Global Liquidity Index (GLI), which aggregates M2 data from various regions and incorporates information from major central banks, such as the Federal Reserve (FED), European Central Bank (ECB), People’s Bank of China (PBC), and Bank of Japan (BOJ), among others. Additionally, it accounts for parameters like the Treasury General Account (TGA) and Reverse Repurchase Agreements (RRP), tools used by the FED to regulate liquidity in the US financial system. Consequently, the GLI provides a comprehensive, though imperfect, measure of global money and credit flows, making it particularly suitable for analyzing correlations with borderless assets like cryptocurrencies. However, this index excludes certain critical liquidity components, such as private banking, interbank transactions, and the euro-dollar market.
Bitcoin and Global Liquidity
The correlation between the GLI and BTC, as well as with most crypto assets, is well-established and widely accepted among researchers. However, this correlation is not absolute. A notable decorrelation often emerges at the onset of a new Bitcoin cycle following the bear market trough, during which the GLI may stabilize while BTC begins its ascent.
Bitcoin was launched in 2009, in the wake of the 2008 financial crisis. At that time, central banks, led by the Federal Reserve, initiated expansive liquidity measures through extensive stimulus programs. This surge in readily available capital created an ideal environment for Bitcoin’s proliferation. Between 2009 and 2013, its market capitalization grew from negligible levels to billions of dollars, propelled by a liquidity wave that encouraged investment in novel and high-risk assets.
XCH and a Different Context
In contrast, Chia (XCH) was introduced in 2021, during a period of shifting global liquidity dynamics. While the COVID-19 pandemic initially triggered stimulus measures, by 2021, central banks began recalibrating their policies to address inflationary pressures, marking the onset of liquidity contraction. This less favorable environment partly may explains why XCH has not replicated Bitcoin’s early explosive growth. Its market capitalization has remained relatively stable, reflecting a market with diminished financial impetus to propel risk assets.
Comparison of the Responses of BTC and XCH Market Capitalizations to Liquidity Changes: The Role of Monetary Inflation Phases
Currently, Bitcoin’s market capitalization has exhibited a sustained upward trend, while Chia’s has stagnated. This divergence persists despite the GLI either declining or remaining stable. A key factor in this disparity—among other potential reasons beyond the scope of this article—is the distinct monetary inflation phases of BTC and XCH, which shape their responses to liquidity conditions.
Bitcoin is in an advanced stage of its monetary issuance cycle, characterized by an exceptionally low inflation rate that severely limits the influx of new BTC into circulation. Consequently, Bitcoin exhibits deflationary characteristics relative to the US dollar’s monetary inflation. Even when the GLI is not expanding, Bitcoin benefits from its relative scarcity.
Conversely, Chia occupies a different phase in its issuance cycle, with a monetary inflation rate significantly higher than that of both Bitcoin and the US dollar. As a result, Chia functions as an inflationary asset relative to the dollar. In an environment where the GLI is not expanding, XCH merely sustains its market capitalization by offsetting its higher monetary inflation relative to the dollar. For XCH to increase its market capitalization, it would require either a reduction in its monetary inflation rate over time or an expansion in the GLI.
Conclusion
Global market liquidity, defined as the accessibility of credit and the availability of money within the financial system, has been instrumental in shaping the trajectories of Bitcoin and XCH. In its origins, Bitcoin capitalized on a period of expansive liquidity to achieve significant growth, whereas XCH has contended with a contractionary environment that has constrained its initial expansion.
To comprehensively assess their performance, it is essential to consider both global liquidity conditions and the distinctive attributes of each asset, particularly their monetary issuance mechanisms. Only through this dual perspective can we gain a clear understanding of their potential within the evolving financial landscape.
Note: In calculating various parameters for XCH, such as supply, market capitalization, and monetary issuance, only the monetary issuance schedule per block of the Chia blockchain and the sales and loans from the CNI strategic reserve have been considered. The CNI hot wallet has been excluded from the circulating supply.
