Understanding the unusual divergence between Bitcoin and stocks and what it means for crypto investors
Bitcoin has fallen 25% since August 2025 while the U.S. stock market rose 10% over the same period. This sharp divergence is unusual because Bitcoin, a high-risk asset, typically rallies alongside equities during bull markets. Is this the start of a Bitcoin bear market or something else? In this article, you'll learn why this divergence doesn't necessarily spell doom for Bitcoin and how key liquidity indicators, like Fed policy and balance sheet moves, shape its path ahead.
Why Is Bitcoin Underperforming When Stocks Are Rising?
Usually, Bitcoin’s price tracks risk appetite closely. When investors chase stocks higher, they often also buy Bitcoin. But this time, Bitcoin slid 25% even as stocks climbed 10%. A similar divergence happened before Bitcoin’s 2021 peak, followed by a brutal 75% bear market crash.
This suggests some investors fear a repeat scenario. But price action alone isn’t enough. To gauge if Bitcoin is in trouble, we must dig deeper into two major liquidity factors that influence Bitcoin's behavior:
- Federal Reserve interest rate policy
- The Fed’s balance sheet size and liquidity conditions
Fed Funds Rate vs. 2-Year Treasury Yield: Measuring Monetary Policy Tightness
The Federal Reserve sets the Fed funds rate, the benchmark interest rate influencing borrowing costs.
- When rates fall, borrowing gets cheaper, money flows into risk assets like Bitcoin.
- When rates rise, borrowing costs increase, tightening financial conditions and pressuring risk assets.
But just knowing whether the Fed cuts or hikes isn’t enough to understand policy stance. We need a comparison: the Fed funds rate versus the 2-year Treasury yield, which reflects bond market expectations for interest rates over the next couple years.
What Does the Fed Funds Rate Minus 2-Year Treasury Yield Tell Us?
- If the Fed funds rate is below the 2-year yield: Policy is accommodative, looser than the market expects.
- If the Fed funds rate is above the 2-year yield: Policy is restrictive, tighter than market expectations.
Right now, this difference remains above zero, meaning policy is still tighter than the market anticipates—even though the Fed has started cutting rates since late 2024. ---
Historical Context: Bitcoin and Fed Policy Stance
- In 2019-2020, a similar setup saw Bitcoin rally 500% after policy moved from restrictive to accommodative.
- Bitcoin’s 2017 bull market top coincided with a reversal from accommodative to restrictive policy.
- Today’s environment shows the Fed leaning toward looser policy ahead, especially with a new Fed chair expected in May 2026 likely to cut rates aggressively.
Investor takeaway: Bitcoin’s correction today looks more like a midcycle pullback than the start of a bear market, given no tight policy shock yet.
The Fed’s Balance Sheet: Liquidity in the Financial System
The other critical factor is the Fed’s balance sheet—the total assets it holds.
- When the balance sheet grows (quantitative easing, QE), it injects liquidity, usually boosting Bitcoin.
- When the balance sheet shrinks (quantitative tightening, QT), liquidity tightens, often coinciding with Bitcoin bear markets.
Interestingly, this bull run is happening while the Fed's balance sheet has contracted—something rare in Bitcoin’s history, seen only twice before in 2012 and 2019. On both occasions, Bitcoin still rallied over 250%, likely helped by accelerating adoption by institutions and sovereign funds.
Liquidity Stress Warning: Bank Reserves vs. GDP
Bank reserves—cash banks hold at the Fed—have fallen from $4.2 trillion in 2021 to $2.9 trillion. Research shows when bank reserves dip below 10–11% of GDP, liquidity stress emerges.
- In 2019, reserves hit 7% of GDP, sparking a liquidity crunch that made the Fed ramp up QE again.
- Today, reserves are at 9.5% of GDP, already inside the 'danger zone.'
With the Fed already buying $40 billion of short-term Treasuries monthly and the potential to increase purchases, liquidity conditions may improve soon, supporting risk assets like Bitcoin.
Answer Box: Is Bitcoin’s current price drop the start of a bear market?
No. Despite Bitcoin's 25% fall since August 2025, key indicators like the Fed funds rate compared to the 2-year Treasury yield and the Fed’s balance sheet suggest monetary policy remains accommodative or loosening. Past patterns show Bitcoin is likely experiencing a midcycle correction, not a full bear market start.
Risks: What Could Go Wrong for Bitcoin Investors?
- Policy surprises: If the Fed unexpectedly tightens more aggressively, Bitcoin could face downwards pressure.
- Liquidity shocks: Further declines in bank reserves risk triggering financial stress, reducing investment appetite.
- Macroeconomic shocks: Black swan events like a pandemic flash crash could derail any forecast.
- Adoption stalls: If institutional inflows slow, demand may not sustain current price levels.
Investors should watch the Fed funds rate vs 2-year yield spread and liquidity indicators closely. These provide early signals of possible shifts in Bitcoin’s trend.
Actionable Summary for Crypto Investors
- Bitcoin’s underperformance vs stocks is unusual but not a clear bear market signal.
- Fed funds rate still above the 2-year Treasury yield means policy remains relatively tight, but loosening likely ahead.
- Fed balance sheet contraction amid this bull run is historically rare but driven by unique institutional adoption factors.
- Bank reserves below 10–11% of GDP signal liquidity stress but Fed balance sheet expansion efforts may ease it.
- The current correction aligns with a typical midcycle dip, not a 2021-style bear market crash.
For investors wanting deeper market signals and model portfolio guidance, Wolfy Wealth PRO delivers timely, data-backed insights and risk management rules tailored to crypto markets.
FAQ
Q1: Why is Bitcoin falling when the stock market is rising?
A1: Bitcoin's divergence from stocks usually signals changing risk sentiment or liquidity conditions. Currently, monetary policy hints and liquidity factors suggest this is a midcycle correction, not a new bear market.
Q2: How does the Fed funds rate vs 2-year Treasury yield affect Bitcoin?
A2: This difference shows monetary policy stiffness relative to market expectations. When Fed funds rate is below the 2-year yield, policy is accommodative and good for Bitcoin; the reverse tightens conditions.
Q3: What role does the Federal Reserve’s balance sheet play in Bitcoin’s price?
A3: An expanding Fed balance sheet injects liquidity, often boosting Bitcoin. QT removes liquidity, typically pressuring Bitcoin. Current liquidity tightening combined with institution-driven demand is an unusual mix.
Q4: What is the significance of bank reserves falling below 10-11% of GDP?
A4: It indicates liquidity stress in the financial system, which can lead to tighter lending and risk asset sell-offs. The Fed may respond by expanding its balance sheet to ease conditions.
Q5: Could Bitcoin still enter a bear market?
A5: Yes, if monetary policy tightens faster than expected or a major economic shock occurs. But right now, signals suggest a midcycle correction phase.
Get the full playbook and entries in today’s Wolfy Wealth PRO brief for in-depth alerts, risk rules, and portfolio strategies to navigate Bitcoin’s evolving landscape confidently.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Cryptocurrency investments carry substantial risks and volatility. Always do your own research and consult a professional before investing.
By Wolfy Wealth - Empowering crypto investors since 2016
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Disclosure: Authors may be crypto investors mentioned in this newsletter. Wolfy Wealth Crypto newsletter, does not represent an offer to trade securities or other financial instruments. Our analyses, information and investment strategies are for informational purposes only, in order to spread knowledge about the crypto market. Any investments in variable income may cause partial or total loss of the capital used. Therefore, the recipient of this newsletter should always develop their own analyses and investment strategies. In addition, any investment decisions should be based on the investor's risk profile
