If You Own Cryptocurrency, You Need to Understand What's Happening With Oil Right Now

The war between the U.S. and Israel and Iran has effectively shut down the Strait of Hormuz, which normally carries about 20% of the world's oil supply, thus producing what the International Energy Agency has deemed the "largest disruption in history" of globl oil supply. Bitcoin (CRYPTO: BTC), Ethereum (CRYPTO: ETH), and most other major cryptocurrencies are highly exposed to that supply shock over the medium term despite their decent performance throughout the conflict so far.

The connection between oil and crypto is via liquidity, which is the quantity of investable capital in the global financial system. Andm if prior energy shocks are any indication, there will be big shifts in liquidity across the system soon, so it's a good idea to get a basic understanding of how it affects the cryptoassets you own.

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Oil prices tend to drive inflation

Expensive oil pushes up inflation because energy costs are included in the cost of all goods and services. Elevated inflation keeps the Federal Reserve from cutting interest rates. Higher interest rates tend to drain the liquidity that risk assets like crypto depend on to climb, because they ensure that safe assets -- particularly government bonds -- yield more, thereby making riskier investments less appealing. This process is only starting to play out.

Brent crude oil is bouncing around just below $100 as I write this, far above the $63 where it started the year. Recently, Federal Reserve Chairman Jerome Powell bluntly stated, "We have an energy shock of some size and duration. We don't know what that will be."

Before the war, markets priced in two interest rate cuts for 2026. Now, it's looking more like rates will be unchanged by the end of the year.

Crypto performs best when money is cheap and plentiful. Right now, money is neither.

Nonetheless, both Bitcoin and Ethereum have outperformed the stock market since the start of the conflict at the end of February. Whereas the market is flat, Bitcoin is up by 6%, and Ethereum is up by 8%. So it's clear that investors aren't giving up on these assets despite the turbulent macro environment.

What could happen next?

At the moment, there are two scenarios worth planning for.

The first one is if the ceasefire holds and the Strait of Hormuz -- which the U.S. is blockading as I write this -- reopens. This scenario should push the price of oil down and ease inflation after a brief spike that's washed out of the system as energy supplies flow freely again. Then the Fed could regain room to cut rates, possibly in the second half of 2026. This is the more favorable scenario for investors by far.

The second possibility worth planning for is that there's no durable ceasefire or the war escalates to include more destruction of energy production facilities or energy transfer infrastructure, either of which would cause the price of oil to spike further, in turn forcing the Fed to stay frozen or discuss rate hikes. If that happens, crypto would likely face another leg down.

It's possible that scarce stores of value like Bitcoin could weather a further downturn fairly gracefully, and Ethereum might fare better than smaller coins, too, but betting on anything other than experiencing medium-term pain is probably a bit too optimistic if this scenario plays out.

What to do?

The most practical move is to keep your crypto portfolio weighted heavily toward the largest, most liquid coins rather than altcoins, which are apt to suffer the most if liquidity withdraws. Both Bitcoin and Ethereum have survived some very difficult macro situations before, like in 2020 and to a much lesser extent in 2022, so there's already some precedent for their performance under those conditions. An energy shock stemming from disrupted oil flows is going to be something new for these cryptos, but in principle, the attending liquidity conditions probably won't be.

Another good step to take is to hold some additional cash. Having "dry powder" on hand will enable you to buy at fire-sale prices if the market gets into a panic due to the energy shock, and it'll also help you to avoid feeling powerless in the face of bearish macro conditions.

The Iran conflict and its consequences will eventually be resolved. When that happens, the liquidity picture for crypto will shift, and oil prices will stop being a drag on prices. Until then, don't get scared out of Bitcoin or Ethereum, and look for opportunities to buy them if sentiment craters.

Alex Carchidi has positions in Bitcoin and Ethereum. The Motley Fool has positions in and recommends Bitcoin and Ethereum. The Motley Fool has a disclosure policy.