Bitcoin has been sliding. These charts show why - and what might happen next.
By Joseph AdinolfiLiquidity has been draining out of the financial system, putting pressure on speculative assets like cryptocurrenciesBitcoin prices have taken a hit recently, and this one chart might offer some clues about what is driving the drop.Bitcoin prices rode a wave of liquidity to a record high in October. But lately, the tide has been going out.Investors have been struggling to pin down exactly what has been driving the broad-based unwind in popular momentum trades in roughly the past month - including a drop in bitcoin prices (BTCUSD) that has seen the pioneering cryptocurrency erase its gains from earlier in the year. Recently, bitcoin was trading about 25% below its record high, FactSet data showed.Many explanations have been proffered - from uneasiness over the aggressive pace of spending in the artificial-intelligence race, to growing anxiety that the Federal Reserve might hold off on cutting its policy interest-rate target when senior officials meet next month.But several strategists and portfolio managers suspect another catalyst looks like a plausible explanation as to why bitcoin, specifically, has come under pressure.In October, investors saw liquidity drain out of the financial system at the fastest pace since 2022, according to an indicator produced by Wells Fargo Securities."A lack of liquidity pushes risk appetite lower, impacting speculative stocks and assets more than others," said Ohsung Kwon, chief equity strategist at Wells Fargo. When liquidity is expanding, the opposite is true.A 'sponge for liquidity'In theory, bitcoin would be a hedge against the debasement of fiat currencies like the U.S. dollar DXY. As global government debt levels look increasingly unsustainable, many investors have turned to crypto as a potential alternative store of value to protect against the waning purchasing power of the dollar and its rivals - at least according to crypto evangelists.But in reality, bitcoin doesn't behave much like a hedge at all. Instead, it trades like an extremely speculative asset.Michael Kramer, portfolio manager at Mott Capital Management, has pointed out that bitcoin often behaves like a leveraged bet on the Nasdaq-100 index NDX.There's data to back up his point: The 21-day rolling correlation between bitcoin and the ProShares UltraPro QQQ TQQQ, which aims to amplify daily swings in the Nasdaq-100 by three times, stood at 0.7 as of this week, according to Dow Jones Market Data.A correlation of 1 means two assets move perfectly in lockstep, while a correlation of 0 suggests no relationship. Although not perfect, a correlation of 0.7 is still pretty high, Kramer noted."I don't think bitcoin has any other value than being a sponge for liquidity," he said.Indeed, shifting levels of liquidity have been a "fairly good predictor of where bitcoin is going," Kramer added. When measuring liquidity, he said he uses some of the same metrics tracked by Wells Fargo, along with a few others.The Wells Fargo gauge incorporates several different inputs, but two of them stood out in October: Reserves in the U.S. banking system declined, while the spread between the secured overnight financing rate and the fed-funds rate widened. Both suggested borrowers were paying more to finance day-to-day operations.Where next?Several near-term momentum indicators have remained skewed to the downside, suggesting bitcoin prices could move even lower in the near term, despite a rebound on Tuesday that briefly pushed prices back toward $95,000 per token.On Monday, bitcoin experienced a "death cross," according to Dow Jones Market Data. A death cross occurs when a 50-day moving average dips below a 200-day moving average, signaling a shift in the intermediate trend of an asset or index. The name might sound ominous, but data show that a death cross is often an indication that a given asset or index has fallen too far and is overdue for a bounce.Yet the death cross wasn't the only technical development concerning the cryptocurrency: The gap between bitcoin's price and its 200-day moving average has reached the widest margin since 2022, Dow Jones Market Data showed.Katie Stockton, a technical strategist and founder of Fairlead Strategies, said she has slightly different criteria for what constitutes a death cross. Nevertheless, she argued in commentary shared with MarketWatch that the drop in bitcoin has so far been in line with historical corrections and downdrafts.Technical guideposts followed by Stockton suggest that bitcoin has indeed entered oversold territory, and could be due for a bounce. But she added that she would like to see intermediate-term metrics improve before waving the all clear.Meanwhile, Kwon and his team at Wells Fargo don't see liquidity conditions in the U.S. improving until early 2026. Wells Fargo economists expect the Federal Reserve will start buying $25 billion a month in short-term Treasury bills beginning in April, or potentially even sooner. The Fed announced in October that it would stop allowing its bond holdings to roll off its balance sheet, beginning on Dec. 1.To stanch the bleeding in more speculative corners of the market, Kramer said he anticipates the Fed will ultimately need to step back into markets to ease some of the pressures currently building in the financial system.Bitcoin prices hit a record high of $126,272.76 on Oct. 6, FactSet data showed. On Tuesday, prices briefly dipped below $90,000 overnight, but have since recovered somewhat. Bitcoin was trading at about $93,000 in afternoon trading.-Joseph AdinolfiThis content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.