Key Highlights

• The Global Liquidity Cycle is rising due to central banks injecting capital into the economy.
• U.S. and Chinese policies are expected to fuel investor appetite for riskier assets like crypto.
• Liquidity expansion could lead to both growth and potential inflation risks for crypto markets.

What is a Global Liquidity Cycle?

The Global Liquidity Cycle refers to the ebb and flow of money in the global financial system, largely driven by central banks.

It tracks the supply of liquid assets available for immediate use, such as cash, deposits, and market tradable assets like bonds. When central banks lower interest rates or inject stimulus into the economy, liquidity rises, making more money available to investors and markets.

Michael Howell, CEO of Cross Border Capital, emphasizes that global liquidity isn’t just about the money in circulation (such as M1 or M2), but includes other financial assets like sovereign bonds and bank reserves.

Howell's four-year liquidity model shows that the current cycle is in a rising phase, which historically has benefitted tradable assets, especially cryptocurrencies.

This rise in liquidity is a key factor influencing the surge in crypto investments, as liquidity often leads to increased risk appetite among investors.

Rising Global Liquidity: Impact on Markets and Crypto

Recent actions by central banks, particularly in the U.S. and China, have led to a sharp increase in global liquidity. For instance, on September 15, the U.S. Federal Reserve cut interest rates by 50 basis points, signaling the start of an easing cycle.

Just a week later, China followed with its most aggressive stimulus package in four years, injecting $143 billion into its economy.

This surge in liquidity is creating a favorable environment for cryptocurrencies, which have shown a strong correlation with liquidity trends. According to data from Lyn Alden Investment Strategy, Bitcoin’s correlation with global liquidity was 0.94 between May 2013 and July 2024.

As liquidity grows, cryptocurrencies like Bitcoin are expected to rise as investors seek higher returns from riskier assets.

Quinten Francois, co-founder of WeRate, notes that liquidity-driven surges often align with historically strong months for crypto, especially in the fourth quarter. "80% of Octobers were green, and every election year has seen strong gains in October, November, and December," Francois said.

How Liquidity Flows Into Crypto Markets

When central banks pump liquidity into the economy, it doesn’t immediately flow into cryptocurrencies. Instead, it first trickles through safer, more traditional markets like bonds and stocks.

As investor confidence grows and markets stabilize, capital begins to shift toward higher-risk assets like Bitcoin and other digital currencies.

China has experienced this dynamic repeatedly over the past two decades. Its large stimulus packages often lead to significant equity market rallies, and as liquidity continues to rise, investors increasingly turn to riskier markets such as crypto.

This phenomenon is referred to as the "trickle-down effect," where liquidity gradually reaches cryptocurrencies after flowing through more established asset classes.

Max Sultakov, CEO of Yona Network, explains, "Historically, Bitcoin has surged during periods of global liquidity expansion. Institutional investors will likely shift more capital into Bitcoin as a hedge against fiat instability."

This expanding liquidity could drive even more capital into decentralized assets, especially in regions with strict capital controls like China.

Risks and Challenges of Liquidity Expansion

While the rise in global liquidity is boosting investor sentiment and demand for cryptocurrencies, experts caution about potential risks.

Economist Daniel Lacalle warns that "exploding liquidity" could lead to long-term consequences, including inflation and economic stagnation. In this scenario, asset bubbles could form, threatening even strong-performing markets like crypto.

The balance between liquidity growth and economic stability is critical for the future of crypto markets. As central banks continue to cut rates and expand liquidity, the flow of capital into crypto will increase, but investors should be aware of the risks.

Fed Chair Jerome Powell recently hinted that more interest rate cuts are likely, though they may be smaller than previous reductions.

Final Note

The Global Liquidity Cycle is a significant force shaping the future of cryptocurrencies. As central banks pump money into the global economy, Bitcoin and other digital assets are expected to benefit from the increased liquidity.

However, investors should remain cautious, as the rising tide of liquidity could also fuel inflation and asset bubbles, impacting the long-term stability of crypto markets.