It has been all bad news for crypto investors recently with coin prices falling by the equivalent of more than a trillion dollars and, worse still, showing an alarming correlation to share markets.
That is particularly the case for the twinned “algorithmic” stablecoins Terra and Luna, which became locked in a joint massive downward spiral that has had quite a contagion effect on the entire crypto world.
Some of that collateral damage has now been unwound with a sharp rally in the prices of the biggest coins – Bitcoin and Ethereum – but it is fair to say that anyone trading in crypto will need nerves of steel to navigate the recent period of extreme volatility.
Just as worrying as highly volatile prices though has been the way they have become correlated with share markets, albeit with added drama.
One of the central ideas behind crypto investments such as Bitcoin was that they should be uncorrelated to many other assets, making them an ideal diversification tool.
With the creation of many coins subject to strict and unchanging mining rules, the “supply” of new coins was well understood which would leave pricing up to demand.
Correlation with markets is quite high
That independent relationship seems to have broken down though, with recent US trading over 40 days showing the correlation with the S&P 500 benchmark and Bitcoin reaching a record 0.82.
A perfect score of 1 would mean the two markets move in absolute lockstep, so it seems like Bitcoin is behaving just like a conventional share at the moment – albeit one with some spectacular volatility.
Of course, that is a very short time to measure any correlation but it points to the concern about Bitcoin in particular and crypto assets in general.
Have frothy markets boosted crypto?
Will they be able to once again break into their own trading pattern or has the combined forces of firming interest rates, falling shares and a new found risk aversion changed the dynamic forever?
We will have to wait and see, but the high correlation with share markets might suggest that the frothy markets that buoyed crypto assets during the days when interest rates were near zero and money printing was everywhere were the aberration and the current volatile trading is the new normal.
If that is so, then there could be some more big falls ahead if previous bear markets in crypto are to be repeated.
At the moment Bitcoin has fallen at one stage by 60% from its all-time high hit in November 2021, although it is closer to a 50% fall at the moment and that drop is mirrored quite closely by many other coins.
A report from analysis firm Glassnode said that the current decline “remains modest when compared to the ultimate lows of prior Bitcoin bear markets”.
In the Bitcoin bear markets of 2015, 2018 and 2020, the Bitcoin valuation fell by between 77% and 86% off the all-time high.
Further downside is possible
“As such, further downside remains a risk, and would be within the realm of historical cycle performance,” Glassnode said.
“Bitcoin remains highly correlated to the broader economic conditions, which suggests the road ahead may unfortunately be a rocky one, at least for the time being.”
Bizarrely, if the correlation theory holds, the best hope for many crypto coins could be a recovery on share markets which given the volatility on crypto markets could lead to an even bigger and stronger rally there too.
The rally in Bitcoin and Ethereum after heavy falls showed that not even massive losses and problems with stable coins have stopped the true believers from buying the dip in what is still a very immature investment asset class.
For now, reports of the death of crypto have been exaggerated but traders will need to be nimble to keep on top of the volatility that is heading their way.
One of the crypto’s most popular catchcries – “Hold On For Dear Life’’ (HODL) – has never been more apt.