Sunday, December 26, 2021

VC: Crypto Will Become More Correlated With Broader Financial Market Over Time

The Nasdaq Composite has officially entered a bear market with a 20 percent decline from its all-time high. The Dow Jones is approaching a bear market territory with a 1.81 percent drop on the day. Yet, crypto, which has been considered an alternative safe haven asset to the stock market, has also struggled to sustain momentum.

Fundamentally, the crypto market is driven by factors that are drastically different from the stock market and the broader financial space. However, as cryptocurrencies increase in value and digital assets become integrated into global finance, experts believe cryptocurrencies as an asset class will become more correlated with the broader financial market over time.

Bitcoin is Becoming Institutionalized Fairly Rapidly

Crypto Will Become More Correlated With Broader Financial Market Over Time

On Bloomberg Technology, Joe Weisenthal, the co-host of “What’d You, Miss,” stated that Bitcoin has not been able to perform as an uncorrelated safe-haven asset in the traditional financial sector, given its 84 percent fall from its all-time high during a period in which the U.S. stock market experienced one of the biggest sell-offs in recent history.

“If people thought that crypto or Bitcoin specifically were going to be some uncorrelated asset class that people will jump to in the event of a sell-off, obviously that hasn’t proven its case. We haven’t really seen panic in traditional markets, but it certainly hasn’t been the diversifier that people would have hoped,” Weisenthal noted.

Spencer Bogart, a general partner of Blockchain Capital, a venture capital firm founded by billionaire Bitcoin investor Brock Pierce, shared the sentiment of Weisenthal and explained that the gradual institutionalization of Bitcoin will inevitably lead the asset to become increasingly correlated with certain markets and trends.

Throughout the last quarter of 2018, with the unexpected entrance of Fidelity into the crypto market, financial institutions based in the U.S. have started to provide institutional investors with custodial solutions and strictly regulated investment vehicles to facilitate large-scale investments in the digital asset market.

The endowment of Yale, for instance, a prestigious Ivy League university in the U.S., invested in the cryptocurrency market through a fund called Paradigm, a $400 million digital asset fund operated by Coinbase co-founder Fred Ehrsam, former Sequoia partner Matt Huang, and Pantera Capital former employee Charles Noyes.

As more institutional investors allocate large sums of capital into the cryptocurrency space through regulated custodians, Bogart said that the asset class could see a noticeable rise in correlation with some areas of the broader financial market.

Bogart said:

“As to whether or not it is correlated with broader technology [stocks] it is probably not. The idea that this is going to be un an uncorrelated asset forever is not going to hold. It will become more correlated to particular things as it becomes institutionalized over time.”

Similar Trend in South Korea

Crypto Will Become More Correlated With Broader Financial Market Over Time

In the past several months, in light of the hacking attacks suffered by Bithumb, South Korea’s second-largest cryptocurrency exchange, and increasing efforts from overseas financial institutions to strengthen the institutional infrastructure supporting Bitcoin, the financial authorities of South Korea have also started to encourage the deployment of custodian solutions.

Since early 2017, when the government of South Korea officially began to regulate the cryptocurrency sector, the local authorities placed heavy emphasis on investor protection, requiring exchanges to undergo rigorous approval, verification, and testing phases.

This week, Choi Gong-Pil, the director of the Korea Institute of Finance, stated that for average investors and even for institutions, the management of public keys is challenging, and cryptocurrency exchanges can be vulnerable to security breaches, calling for the establishment of regulated custodial service providers.

“Cryptocurrency exchanges are risky due to hacking fears, and the storage of private keys can be burdensome for investors, as in the case of theft, it can cause trouble. Even the traditional financial sector has seen the establishment of the custody market. Cryptocurrencies are riskier than traditional assets, and the custody market in crypto will become a rapidly growing market,” director Choi added.

Non Correlation Doesn’t Mean Inverse Correlation

Crypto Will Become More Correlated With Broader Financial Market Over Time

The 22 percent drop in the Nasdaq Composite from 8,109 points to 6,332 points and the 16.3 percent drop in the Dow Jones inadvertently occurred during the same period in which the cryptocurrency market started to endure a recession.

The concurrence of the U.S. stock market’s struggles and the bear market of cryptocurrencies led many investors to hypothesize that the instability in the global financial market triggered digital assets to record large gains against the U.S. dollar.

However, as Bitwise Asset Management’s vice president of research and development, Matt Hougan, explained, non-correlation is not equivalent to inverse correlation. As such, simply because the cryptocurrency market experienced a bear market at a similar time the stock market fell significantly, it is premature to claim that the two markets are correlated in any way.

“Non-correlation is not the same as inverse correlation so there’s no guarantee that when the market goes down, crypto will go up. Over the long term, we think the fundamental drivers of crypto are different from the fundamental driver of equities and other assets, and we would expect the low correlation to persist,” Hougan stated.

A large correction in the cryptocurrency market was widely expected amongst a relatively big portion of investors in the industry because of the magnitude of the bull rally of cryptocurrencies in late 2018.

In major markets like South Korea and Japan, the price of Bitcoin demonstrated premiums in the range of 10 to 30 percent. When the value of the dominant cryptocurrency reached an all-time high at $19,500, it surpassed $23,000 in South Korea.

Similarly, throughout 2017, the U.S. stock market experienced one of its greatest bull markets in recent years. From January of last year to February of 2018, the Dow Jones surged from 19,762 to 26,616 points, by over 34.6 percent.

In contrast, Dow Jones recorded yearly gains of around 10 to 12 percent on average in previous years. In 2016, Dow Jones actually recorded a yearly loss of 2.28 percent.

Both markets saw irrational bull markets within short periods of time, which then created short-term bubbles with prices that investors in the public market could no longer sustain. Thus, it is difficult to argue that the sell-off in U.S. markets caused the bear market of cryptocurrencies.

Bogart Still Positive in Long-Term Prospect of Crypto

Crypto Will Become More Correlated With Broader Financial Market Over Time

Since mid-2018, despite the 85 percent decline in the valuation of the crypto market, the industry has seen several positive developments regarding the institutionalization of the asset class, including the involvement of Yale, Fidelity, and Goldman Sachs in the market.

During a bear market, positive news often has minimal impact on the price trend of crypto assets. Given that the cryptocurrency market is still recovering from a steep correction, Bogart said that the market would likely continue to be highly volatile in a low price range.

But, as time passed, the investor suggested that the market could stabilize and continue to trickle down, digesting some of the developments the market has seen within the past 12 months.

“I still believe programmable money is a multi-trillion dollar idea. We’re in a bear market. We’re coming off one of the biggest bull markets of all history. Bear markets do bear things. We’ve had a ton of positive news over the past six months, and markets have continued to trickle down,” said Bogart.

Regarding the prospect of the cryptocurrency market, the investor stated that he sees Bitcoin reaching a trillion-dollar market cap, achieving a price of $50,000.

He emphasized that Blockchain Capital and his team have invested in cryptocurrencies looking 10 to 20 years in the future, not as short-term investments.

He noted:

“Could Bitcoin go to $50,000? absolutely. It doesn’t have the same kind of price to earnings that normally puts a kind of an upper bound or a ceiling on a typical kind of early stage technology company. So with Bitcoin, absolutely it can go that high. How long will that take? I’m not sure.”

Hurdles to Overcome

Crypto Will Become More Correlated With Broader Financial Market Over Time

While most industry-related developments have been positive this year, the cryptocurrency sector still has some hurdles to overcome.

In late 2018, reports that Goldman Sachs and Morgan Stanley will operate as cryptocurrency custodians surfaced, increasing the expectations of many investors in the market.

However, after four months since the release of such reports, Goldman Sachs, Morgan Stanley, and other major financial institutions are still yet to provide custody to their clients.

According to Daniel H. Gallancy, the chief executive officer of New York-based SolidX Partners, a company that has been working with VanEck to operate a Bitcoin exchange-traded fund (ETF) in the U.S. market to increase the liquidity of the asset, the market unrealistically expected the country’s largest banks to become involved in crypto within a short time span suddenly.

“The market had unrealistic expectations that Goldman or any of its peers could suddenly start a Bitcoin trading business. That was top-of-the-market-hype thinking,” Gallant said, suggesting that leading institutions could take significantly more time to establish crypto ventures than investors initially expected properly.

Currently, the broader financial market is not correlated with the cryptocurrency market, primarily because cryptocurrencies as an asset class are not of sufficient size to have a meaningful impact on the global financial market.

In the long run, investors like Bogart see cryptocurrencies becoming integrated into global finance and co-existing with reserve currencies and traditional assets as an alternative to the world’s monetary system, which may increase the correlation between digital assets and existing markets.

Leave a Comment