Two-thirds of the crypto correction to global macro factors

• As the crypto market matures and blends itself into the global financial system, “market efficiency” plays a key role in understanding the price swings.
• Coinbase owes two-thirds of the global crypto market decline to the current macro conditions.

There’s been a massive bloodbath on Satoshi Street this year in 2022, especially over the last two months. The broader cryptocurrency market has lost 66 percent of its valuations in just eight months since the November 2021 peak of $2.9 trillion.

As cryptos have been on the path of massive wealth erosion, Coinbase takes a look at the market efficiency in its newly published research report. Coinbase says that 70 percent of corrections in the crypto space are nothing unusual. The research report states that since 2010, there have been nine such instances where the crypto market plunged over 20 percent in a single quarter.

Interestingly, every time in such bear market conditions, the market takes two kinds of responses.

1. Crypto Is Dead: Market players start seeing crypto as a big Ponzi scheme destined to fail. There’s massive anxiety and despair among investors leading to severe FUD. Responders in this category see the price drops as the bubble burst and advice everyone to exit before their investments turn to zero.
2. The HODL response: Respondents in this category believe that investors should continue to HODL for a longer period to reap returns. These respondents see crypto usually as a ground-breaking technology in order to support their conviction.

Coinbase notes that neither of these approaches “explains both the historical trends we have seen in crypto and how we are seeing the correlation with overall stock markets today”. Thus, Coinbase considers looking at the aspect of “market efficiency”.

Understanding the crypto market efficiency

Coinbase explains the “market efficiency” response where prices reflect the market’s assessment of the future of cryptocurrencies.

Over the last five years from June 2017, the crypto market has gained over 860 percent, suggesting a brighter outlook for the market. In this period, there was growth in institutional and retail adoption of digital assets. Furthermore, the crypto market witnessed major developments with NFTs and the foundations of Web 3.0. These factors have also contributed to catapulting strong growth for digital assets.

Since the March 2020 crash, the correlation between stock and the crypto market has surged rapidly. This wasn’t quite true for Bitcoin’s first decade of existence before the COVID-19 crash. However, the growing correlation explains that cryptos are getting more and more intertwined with the global financial system. Thus, they are subject to the same economic forces as the global economy.

As per Coinbase, cryptocurrencies have similar risk profiles as tech stocks and oil commodities. Coinbase explains this with an interesting graphic wherein bitcoin and Ethereum have a growing beta to stocks. This means that the world’s two largest cryptocurrencies have a growing correlation to technology stocks. Coinbase noted:

The animation below shows that the betas of bitcoin and ethereum have jumped from 0 in 2019, to 1 in 2020–2021, and to 2 today.

Courtesy: Coinbase

Crypto market and macro conditions

Coinbase adds that with strong U.S. monetary tightening, risk-ON assets like crypto and stocks are dropping fast. But Coinbase adds that not all of the crypto corrections can be attributed to the macro conditions.

Now, the S&P 500 declined 19 percent so far in 2022. On the other hand, the broader crypto market corrected 57 percent. Considering a beta of 2, the crypto market should ideally correct 38 percent. Coinbase says:

We can thus roughly estimate that two-thirds of the recent decline in crypto prices can be attributed to macro factors, and one-third to a weakening of the outlook solely for cryptocurrencies.

Commenting on the future direction of crypto, Coinbase says that it all depends on how the market perceives it to be. The market momentum will change only when the current bearish outlook for cryptos changes.

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