Could Money Supply Predict Bitcoin Prices?

By Ocean Deng


Money supply is an important indicator for studying the overall trends of capital markets. It's often called M1, a term that refers to physical currency, coins, demand deposits, traveler's checks, and other checkable deposits. Basically, it refers to the most liquid parts of the financial system, the things that either are cash or can be quickly converted into cash.   


M1 can be used as an indicator when predicting things like economic development, micro-entity profitability and liquidity, inflation rates, etc. 


In the narrow sense, as it fluctuates, M1 reflects changes in the direct purchasing power of residents and enterprises. That's why it's often used to measure the current level of economic development. But can we learn something about cryptocurrency markets by comparing Bitcoin's price to M1? Is M1, a good indicator for traditional markets, also a meaningful indicator for Bitcoin?


When comparing the US Dollar M1 year-on-year growth rate from January 2013 to June 2019 with the Bitcoin price during the same period, we found that the correlation between the two was only -0.53, indicating there wasn't much of a relationship between these two numbers. Looking at the chart, we can also see that the growth rate of M1 was more volatile. 


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Based on the overall results, it doesn't look like there's much connection between M1 and Bitcoin. But interestingly, if we look more closely at the period after December 2017, there is an apparent convergence. We can see the price trend of Bitcoin and the growth rate of US M1 suddenly coming together. At that same time, the correlation coefficient of the two reached 0.78, showing a significant correlation. 



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Moving forward in time, we can see that both the M1 year-on-year growth rate and the price of Bitcoin bottomed out between January and March 2019, and rebounded in April. 


So is a correlation starting to develop? We don't yet have enough data to be sure, but what we can see in these charts certainly suggests that as the digital money market continues to mature, the money supply may gradually have more impact on the price trends of digital currencies. If that proves true in the years to come, M1 could become a reliable indicator for Bitcoin's price, just as it is for many traditional economic metrics.


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