Bitcoin and the US dollar

Bitcoin and the US dollar

The US dollar has long played a major role in global markets. For most of the last century, such role has been widely supported by the strength of the US economy and its openness to trade and capital flows. As a result, the dollar’s presence in global trade, international debt and non-bank borrowing has led the greenback’s share of global foreign-exchange reserves as high as 70% as of late 90s. That share decreased to less than 60% over the last two decades. 

Given its outsized role in global capital markets, the value of the US dollar relative to other currencies critically impacts global liquidity conditions, which, in turn, influences capital allocation and investment decisions particularly in risky assets, such as high-yield bonds, equity, and possibly cryptoassets. When the dollar rallies, those with high external debt financing, i.e., dollar borrowings, face higher debt servicing costs. This leads to tightening financing conditions and deleveraging, and ultimately unwinding exposure to risk assets. The weakening of the dollar has the opposite effect. 

By serving as a barometer to global liquidity conditions, the US dollar index (DXY) offers some interesting insight into the nature of Bitcoin as a risky asset, and ultimately on the relationship between Bitcoin and the US monetary policy. On the one hand US dollar is the dominant fiat currency used for Bitcoin trading and also for stablecoins. On the other hand, a dollar appreciation/depreciation arguably reflects, as an approximation, investors’ expectations on inflation, monetary policy, and economic growth more generally. 

In this article, I discuss the link between DXY and Bitcoin through the lens of USD as the global reserve currency. By looking at the composition of foreign currency debt issuance and foreign exchange reserves as well as the correlation between DXY and emerging markets, in this article I try to shed some light on the “Long USD = Short BTC” narrative often heard by market participants and/or commentators. 

The role of the US dollar in the global economy

How does the DXY affect asset prices in global markets? The answer lies in the fact that the US dollar is universally viewed as the world’s reserve currency. Despite a diminishing weight in foreign exchange reserves over the last two decades, the reality is that as high as 60% of the global reserves are held in US dollar worldwide. As per the data from the International Monetary Fund (IMF, see here), the US dollar comprises 58% of disclosed global official foreign reserves as of the end of 2022. 

This is far more than the global disclosed reserves held in Euros (21%), Japanese yen (6%), British pound (5%) and Chinese renminbi (3%). Among the US dollar reserves, the majority is held by US Treasury securities, which are popular among official and private foreign investors. As of the end of 2022, $7.4 trillion (31% of marketable Treasury securities) were held by foreign investors, against 48% held by domestic investors. Foreign investors are also among major holders of paper banknotes. According to estimates from the Federal Reserve Board, over 1$ trillion in US dollar paper banknotes are held by foreigners as of the end of 2022. This is approximately 50% of the total amount of US bank notes outstanding. 

The dominant role of the US dollar does not stop at being a reserve currency and/or store of value for foreign investors. The US dollar is also dominant in international transactions and financial markets at large. As of 2019, the US dollar accounts for around 79% of the trade invoicing outside Europe and the US, and around 74% in the Asia-Pacific region. In part because of its dominant role as a means of payment, the US dollar also plays a major role when it comes to international banking and debt issuance. 

As per the Federal Reserve Board estimates, as of the end of 2022, the percentage of foreign currency debt denominated in US dollars was around 70% of the total foreign currency debt issuance. To put that into perspective, this compares to a mere 21% of foreign debt issuance denominated in Euros, and an almost irrelevant 3% denominated in British Pound. The sources of dollar demand from trade, debt issuance and financial transactions also mechanically reflects into a dominant role of the US dollar in foreign exchange (FX) markets. According to the Bank of International Settlements (BIS), the US dollar has been bought and sold in approximately 88% of global FX transactions as of April 2022. 

Although this does not necessarily guarantee a dominant role in the near future, the predominance of the US dollar in global capital markets has been relatively stable over the last few years. Overall, it is fair to assume that the US dollar index’s fate will affect global liquidity conditions, and in turn risk propensity and investments in risky assets for years to come.

Bitcoin and the US dollar index

Over the last decade, the US dollar became a widely used funding currency on the expectation of low interest rates for a prolonged period of time, which has led to its inverse correlation with the stock market. However, as the dollar strengthened over the last 18 months against major currencies, investors may have overlooked potential spillovers to risky assets. Indeed, the implications of a stronger dollar are far from obvious in the current economic landscape. Continued U.S. dollar strength could complicate the outlook for the economy and markets, implications that may be underappreciated when it comes to Bitcoin and cryptoasset markets more generally. Figure 1 shows highlights this point.

Over the time period analysed, there is a rather clear negative correlation between the US dollar and the price of Bitcoin in USD. That is, a strong dollar could spell risk-off in cryptoasset markets due to tightening liquidity and increasing risk aversion. When the greenback rallies, those with dollar borrowings face higher debt servicing costs and scale-back exposure to risk-on assets. This could have persistent implications as the so-called “Fed pivot” to a more accommodating monetary policy is not  in sight. The right panel not only supports such negative correlation between DXY and Bitcoin, but also that such correlation is not necessarily linear. Specifically, there is a less clear correlation for low level of Bitcoin prices vs DXY, while there is clearer evidence of a possible negative relationship between Bitcoin and DXY for higher valuations.

Figure 1: Bitcoin and the US dollar index


Source: Aaro Capital Research
Notes: The left panel shows the Bitcoin price in USD (orange line) and the US dollar index (DXY, blue line). The right panel shows the scatterplot of the two series over the sample period. The sample is from March 2019 to July 2023.

A soaring dollar adds risks to risky assets, of which emerging markets are somewhat related to. A strong dollar tends to bode ill for economies and markets that are dependent on dollar-denominated debt by making it harder for them to service this debt. One can think of the inverse relationship between Bitcoin and DXY as being reminiscent of the inverse correlation between the US dollar and equity emerging markets. The left panel of Figure 2 makes this case in point. 

Figure 2: Bitcoin as emerging market?


Source: Aaro Capital Research
Notes: The left panel shows the US dollar index (DXY, blue line) against the iShares MSCI Emerging markets index (green line). The right panel shows the BTC/USD pair (orange line) against the iShares MSCI Emerging markets index (green line).The sample is from March 2019 to July 2023. 

There is a rather clear negative correlation between emerging markets and DXY since the COVID-19 outbreak. The reason of such negative correlation is predominantly linked to an aggressive monetary policy in the US and the increasing concerns for the economic outlook of emerging economies. As the Federal Reserve hikes interest rates, debt denominated in foreign currency becomes more expensive to repay. This has dampening effects on growth, with investors pulling out funds from domestic markets into US Treasuries. A strong dollar also weighs on trade for emerging economies (see discussion above about foreign invoicing). For instance, firms operating in non-dollar economies will find more expensive to buy commodities. As the dollar strengthens imports become expensive (in domestic currency terms), thus forcing firms to reduce their investments or spend more on crucial imports. For this reason, a stronger dollar has negatively weighed on emerging markets as per the left panel of Figure 2.

Interestingly, since the COVID-19 outbreak the data show a perhaps unexpected similarity between the BTC/USD pair and equity in emerging markets. The right panel of Figure 2 emphasises this point. Since early 2020, the iShares MSCI Emerging markets almost mimicked the trajectory of the BTC/USC pair. Clearly, correlation does not mean causation; there could be a variety of reasons behind such correlation. For instance, deleveraging and flight-to-safety could all be viable explanations for such common price behaviour as investors pull out from risky investments, being Bitcoin or risky emerging economies. 

Conclusions and remarks

The negative correlation between the US dollar index and Bitcoin seems to be well and alive as of July 2023. This has reversed the brief let-up witnessed in March, indicating the possibility of accelerated gains in Bitcoin as the DXY slides downward following growing concerns about the US economic fundamentals for the coming months. Several economic indicators and bond market metrics, such as the slope of the yield curve, have been warning of a recession for some time now. The DXY has declined by over 12% since early October following hopes that the Federal Reserve would pivot to liquidity easing to support the economy.

To a large extent, Bitcoin and the DXY have been mostly negatively correlated over the past few years, except when crypto-specific factors overshadowed the dollar trends. Indeed, the price of bitcoin, and cryptoassets more generally, has been susceptible to news in the short term. This article provides some preliminary evidence that in the medium-to-long term, by crypto markets standards, a strong dollar may be bad for Bitcoin like is bad for emerging markets and any other highly risky asset class. However, this is a short dataset over a single cycle and also does not analyse other possible drivers of Bitcoin and crypto, as well as other rich data sources which are key to substantiating any causal relationship.


Aaro Capital is the trading name of Aaro Capital Limited (“Aaro”), a private limited company, registered in England and Wales with number 11419585, whose registered office is at 5th Floor, 10-12 Eastcheap, London, United Kingdom, EC3M 1AJ.

The material provided in this document is being provided for general informational purposes. Aaro does not provide, and does not hold itself out as providing, investment advice and the information provided in this document] should not be relied upon or form the basis of any investment decision nor for the potential suitability of any particular investment. The figures shown in this presentation refer to the past or are provided as examples only. Past performance is not reliable indicator of future results.

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