Lately, I've been thinking about a question: why are cryptocurrency markets sometimes extremely hot, and other times experience sharp pullbacks? It’s actually largely related to an economic indicator—money supply.

Simply put, M1 is the most liquid money in circulation, including cash and demand deposits that can be used for transactions immediately. In comparison, M2 is much broader; it includes all components of M1 plus savings deposits and time deposits, which are slightly less liquid assets. As for M3, that’s the most comprehensive measure, covering everything in M1 and M2 plus various institutional money market funds and large time deposits.

I’ve noticed an interesting pattern. When the central bank injects liquidity, causing M1 and M2 to increase significantly, liquidity in the entire economy becomes especially abundant. Borrowing becomes easier, and the willingness to consume and invest also rises. During this time, asset prices generally go up—stocks, real estate, cryptocurrencies all rise together. Remember the Bitcoin bull market from 2020 to 2021? That was a direct result of the central bank massively expanding M2, with retail and institutional investors having ample funds to speculate.

Conversely, when M1 and M2 start contracting, the situation is completely different. Liquidity tightens, and speculative funds quickly dry up. During these periods, cryptocurrency prices often fall even more sharply than stocks because their volatility is inherently higher. Investors begin to hedge risks, shifting money into cash or bonds, and regulatory concerns can also intensify selling pressure.

Interestingly, cryptocurrencies tend to perform even better than traditional assets in high-liquidity environments. This is because many see them as a hedge against fiat currency devaluation. Plus, with more disposable income among retail investors, money naturally flows into this market. So, to understand the trends in the crypto market, observing the changes in M1 and M2 can often reveal valuable clues.