BTC Dominance and Market Fluctuation
Many people have probably asked themselves this question before and it had left them wondering and pondering. The question is, why does the rise and fall of Bitcoin price have such a big effect on the entire cryptocurrency market, to the extent of even affecting altcoins that seem to have no direct relation to Bitcoin?
I am not a financial expert and I am not schooled in any financial discipline but I did a little digging around and the most logical answer to the question is quite straightforward; it is due to market pairings and liquidity pools.
In this article, I am avoiding the technical workings and simply presenting this in a simple form that I hope everyone can understand.
Bitcoin (BTC) is considered a major cryptocurrency asset. As a result, many exchanges (both DEX and CEX) provide market pairs or liquidity pools that have BTC as the quote asset.
Note 1: In a market pair, the first currency is called the BASE asset and the second currency is called the QUOTE asset. For example, in ETH/BTC pair, ETH is the base asset and BTC is the quote asset
Note 2: A market pair defines how much quote asset is needed to buy 1 unit of base asset
In simple and general terms, the quote asset is the measurement standard for the base asset, so a change in the price of a quote asset will directly affect the price of the other asset in the pair. For example, if we have an ETH/BTC pair, a change in the price of BTC is likely to also affect the price of ETH due to the fact that they are paired together.
So why does it then affect other cryptocurrency assets that are not paired directly with BTC? The answer is because ETH (from our example) can also be the quote asset in another pair (for instance, BAL/ETH). So when BTC price affects ETH due to ETH/BTC pair, the new ETH price also affects BAL price due to the BAL/ETH pair and the ripple effect continues and ends up affecting almost all cryptos because nearly every crypto has at least one market pair with other cryptos. Since BTC has a market pair with most of the major altcoins, the end result is that if BTC price goes up, nearly all altcoin prices also go up and if it goes down, the reverse happens.
The only exception to this effect seems to be stablecoins. Market pairs that involve stablecoins are not supposed to be affected by this because stablecoins are "stable". Theoretically, if all market pairs are changed so that every crypto only trades directly with stablecoins in market pairings and liquidity pools, then the effect of price fluctuations of BTC and other major altcoins on the general crypto market will be greatly reduced.
In such a scenario, trading ETH for BTC could require two pairs ETH/USDT and BTC/USDT and will require a route such as ETH -> USDT -> BTC. This isolates ETH from being directly affected by the price of BTC.
The question now is, if stablecoins provide such a buffer, why is this approach not being implemented to break the effect of BTC on the market? To be honest, I don't know. As it stands, that is a question for another research.
In summary, there are many factors that affect how the market behaves but market pairings are a major factor when it comes to how and why BTC price action affects the general crypto market. As stated earlier, this article is just a casual examination of the topic and not a technical paper.
Thanks for reading.