Recently, I’ve been thinking about a question: why do cryptocurrencies sometimes experience rapid surges, while at other times they crash dramatically? I’ve found that the answer might be related to an economic indicator that many people overlook — the money supply.

Starting from the basics. The concepts of M1 and M2 money are actually quite important. M1 is the most liquid part of the money supply, including cash in your pocket, demand deposits, and checking accounts — things that can be used for transactions immediately. Simply put, M1 is the most “active” money in the economy, and economists often use it to measure how much money is circulating in a country.

M2 is much broader. It includes all components of M1, plus savings deposits, money market funds, and other assets with slightly lower liquidity. While the money in M2 can also be converted to cash relatively quickly, it’s not as direct as M1. The Federal Reserve used to publish M3 data (an even broader measure of the money supply), but they stopped doing so in 2006.

So, what does this have to do with cryptocurrencies? A lot, actually. When M1 and M2 increase, it means liquidity in the market is abundant — more money means more confidence, making borrowing and spending easier. What happens then? Asset prices generally rise — stocks, real estate, and cryptocurrencies all go up.

Especially for cryptocurrencies, a high liquidity environment often benefits them more than traditional stocks. Why? First, because retail investors have more disposable income to speculate with. Second, because cryptocurrencies are viewed as a hedge against fiat currency devaluation. Bitcoin, Ethereum, and altcoins tend to rally in bull markets. The huge Bitcoin bull run from 2020 to 2021 was driven by massive M2 expansion — central banks around the world were flooding the market with money, with nowhere else to put it.

Conversely, when M1 and M2 contract, liquidity tightens. Retail investors and institutions have less money to speculate with. During these times, crypto prices usually fall even more sharply than stocks because of their inherent volatility. Investors start to seek safety, rushing into cash and bonds, which increases selling pressure on cryptocurrencies.

So, my current view is that if you want to understand the big cycles of the crypto market, changes in M1 and M2 money supply are very useful indicators. Not that they can predict everything, but they can help you understand why markets are especially hot during certain periods and particularly cold during others. Next time you’re analyzing the market, consider paying attention to these macroeconomic data — you might find some valuable opportunities.