Crypto’s downturn is about more than the macro environment
It’s been a tough year for risk assets across the board, and it’s fair to blame the macroeconomic situation. A combination of factors has ignited a wave of inflation in developed economies and forced central bankers to react.
As a consequence, several events – including inflation, wages, interest rate announcements and speeches from monetary authorities (especially in the US) – have had a relevant impact on risk asset prices globally. As bad news prevailed, the turmoil spread across various asset classes and regions. In mid-September, all the most important stock indices from developed countries recorded double-digit negative returns (year-to-date, currency-adjusted).
In these turbulent waters, crypto assets were severely damaged. The Nasdaq Crypto Index (NCI), which represents the performance of the most relevant crypto assets, had fallen 52.3% (year-to-date) by September 12. During this crisis, crypto also showed an unprecedented high correlation with traditionally risky assets, particularly stocks of technology companies, which constituted one of the most damaged sectors. Under these circumstances, it is worth questioning whether the crypto winter is the result of a macro scenario. Let’s see what the data can tell us.
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We fitted a simple regression model to understand how macro shocks affect NCI returns. We used the Nasdaq 100 (NDX) returns, which are highly correlated to crypto, as a proxy variable for changes in the macro landscape. Our data-driven approach also indicated two extreme dates that required special treatment, but we will explore this later. Using daily returns from March 1 to September 12, the estimate indicates that for a 1% variation in the NDX, one should expect a 1.27% variation in the NCI. Considering that the NDX had fallen 21.9% by September 12, we can conclude that 27.0% of NCI’s negative return was directly caused by the macroeconomic situation. This is definitely a significant amount, but there is still a 34.6% drop to be explained. Can we declare macro “not guilty” of this remaining inconvenience? The model gives us some clues.
The two outlier dates were identified solely using data-driven criteria. But if you look closely, there is some meaningful storytelling surrounding these dates. The first date is May 9, which coincides with the collapse of Terra (an algorithmic stablecoin ecosystem), and the second is June 13, the same day Celsius, the then leading centralized crypto lending platform, stopped withdrawals. According to the model, these two days are responsible for a 22.4% drop, with the latter accounting for two-thirds of the decline.
Both Terra and Celsius are examples of classic financial disasters: a currency crisis and the bankruptcy of supervised agents, respectively. These situations usually occur when risk aversion increases (exactly what happens during large and widespread crises). A famous quote attributed to Warren Buffett fits this idea quite well: “You don’t find out who’s been swimming naked until the tide goes out.” While it is not fair to place all the blame on the macro environment for these events, it is hard to believe that it did not play a key role in accelerating the deadly spirals and amplifying the spillover effect across the rest of the crypto ecosystem. It would be fair to classify these two cases as macro-enhanced crypto-specific events (what a fancy name).
After removing the effect of the two outlier dates, we land on a negative return of 15.5%, which can be described as pure crypto performance. Well, if you call it a winter, you probably live pretty close to the equator. The diagram below shows the alternative paths implied by the model:
All this statistical gymnastics is great, but what does it mean for investors who have witnessed half the market’s meltdown? First, despite the high correlation, the links between the current macro situation and the future possibilities of crypto and blockchain technologies are extremely weak. There is no reason to believe that this crisis will have an impact on the long-term performance of crypto investments.
Second, the macro-enhanced crypto-specific events that have had a significant impact on prices were purely technical and had no effect on the fundamentals of the investment case. It is reasonable to expect that the effect will be reversed in the medium term.
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Third, the crypto ecosystem is fine. The crisis washed away some bad actors and poorly designed projects, but all the pillars stand intact. Decentralized financial protocols (DeFi) worked as expected. Ethereum has just completed the most relevant update in crypto history. Second-tier solutions are under development. There is increasing use of non-fungible tokens (NFTs) and other forms of digital culture, and so on.
Crypto’s downturn isn’t just about macro. But it is likely that we would be in for a pleasant autumn if it were not for the crisis. And why should we be skeptical about the possibility of a crypto summer after the macro turmoil subsides? It has been said: “To appreciate the beauty of a snowflake, it is necessary to stand out in the cold.” To tan in the crypto summer, you have to be exposed.
João Marco Braga da Cunha is a portfolio manager at Hashdex. He obtained a master’s degree in economics from the Fundação Getulio Vargas before obtaining a doctorate in electrical and electronic engineering from the Pontifical Catholic University of Rio de Janeiro.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
