- The U.S. Dollar Index is negatively correlated to Bitcoin and has been since 2013
- Bitcoin has tended to go up when the U.S. Dollar Index has gone down, and visa versa
- Bitcoin’s bull run could be stalled by what the U.S. dollar does next
Bitcoin’s correlation to some traditional markets like the S&P 500 has been well documented in recent months, but there is another correlation that is even stronger and goes back further – the U.S. Dollar Index. But what is the U.S. Dollar Index and why should Bitcoin holders care? Let us explain.
What is the U.S. Dollar Index?
The U.S. Dollar Index represents the value of the U.S. dollar relative to a basket of six currencies – EUR, JPY, GBP, CAD, SEK, and CHF. The index goes up when the U.S. dollar gains strength (value) when compared to the other currencies and drops when it weakens against them. It was introduced in March 1973 on the heels of the removal of the dollar from the gold standard as a way of measuring the value of the fiat currency, and over the years has, naturally, fluctuated quite considerably:
The value of the dollar compared to a basket of other currencies might not seem that relevant to the Bitcoin price, but this couldn’t be further from the truth, as we can see when we overlay Bitcoin’s price action in blue over the U.S. Dollar Index chart:
As we can clearly see, when the dollar is performing well Bitcoin performs badly and visa versa. This has been particularly evident during the coronavirus pandemic this year:
So why is this negative correlation so strong? The issue has to do with how Bitcoin’s purpose in the past has changed over the years. It always had ideals of being an alternative to fiat currencies and the global machinery that goes with it, but for many years its importance was dismissed. This can be evidenced by the fact that until around 2013 there was no correlation to speak of.
However, as time has passed and Bitcoin’s stock has grown, it has become seen as another alternative to precious metals which typically rise when the notably fragile economy is in a time of crisis, which it is right now – people are fleeing from fiat currencies and looking for alternative ways to store their wealth.
Bitcoin was first used for this purpose by Cypriots during their banking crisis of 2013, and that template has been followed this year – like gold and silver, Bitcoin initially crashed in March but has since made an almost 3x gain while the value of the dollar has plummeted. All this speaks to Bitcoin’s growing influence in the world economy.
The Impact on Bitcoin
So what can the U.S. Dollar Index tell us about Bitcoin’s short term future, and more importantly the likelihood of a bull run after Bitcoin jumped $11,000 yesterday? Following a two-year period of growth, the strength of the U.S. dollar has fallen off a cliff since the Federal Reserve promised to print trillions of dollars to help battle the impact of coronavirus. This has led to the dollar breaching a support line that started way back in May of 2011:
The significance of this cannot be overstated, as it puts the U.S. Dollar Index in a very sensitive position. On one hand, breaching this support in itself is bad, but when you factor in the knowledge that another round of stimulus checks will require the printing of trillions more dollars in a matter of weeks, it is tempting to think that the dollar’s strength could be about to plummet to the lows of March 2018 and perhaps further.
On the flip side, the dollar is now in severely oversold territory, the most it has been for 52 years, meaning that, technically at least, it is in line for a reversal. Indeed, the bleeding seems to have stopped, with an attempted bounce in progress at the time of writing:
It will be fascinating to see how this situation plays out for a number of reasons, and Bitcoin fans will be hoping that the dollar capitulates further, meaning more of a flight to the cryptocurrency and a chance for Bitcoin to spread its wings and make further gains. Were the U.S. Dollar Index to perform an about face and set about reclaiming the ground it has spent over four months losing however, then Bitcoin’s bull run could be cut short just as it is getting going.