The crypto market is maturing and becoming more efficient and one of the outcomes is that the market has become more sensitive towards changes in the macroeconomic environment. This simply means it is no longer a game within a small group of crypto-natives.
Just over a year ago, the crypto market was thriving. As it becomes more mainstream, Microsoft, Starbucks and Wikipedia were among one of the few big firms which started to accept crypto as a form of payment method. At the same time, payment giants Mastercard, Visa and PayPal entered the scene, paving the way for greater retail crypto adoption.
In addition, institutional adoption of crypto also surged. As of date, institutional investors like MicroStrategy, Galaxy Digital Holdings, and Tesla continue to purchase Bitcoin as an asset to their balance sheets. Furthermore, several traditional finance institutions also started to offer crypto custody services in an attempt to unlock institutional investors’ interests. Prominent players such as JPMorgan, Goldman Sachs and DBS Bank all jumped on the bandwagon to stake their claim on their share of the crypto pie.
Many used to believe crypto, in particular Bitcoin, was an inflation hedge due to it having a fixed supply. However, the release of September’s CPI YoY and MoM reports came in at 8.3% and 0.1% respectively, beating the forecasted value by 0.2% — this weakened the argument often made by crypto enthusiasts. Bitcoin plummeted close to 6% in under 30 minutes upon the news release.
To understand how macro factors influence the crypto market, we need to understand its underlying mechanism such as the various macro metrics like inflation, interest rates, etc.
How do global events affect Bitcoin?
Like fiat money, Bitcoin is affected by the economies it is used in. Due to the decentralised nature of Bitcoin and blockchain technology, a correlation can be seen between its price and that of tech stocks (e.g., Meta and Apple). It is possible that investors appear to be treating crypto like tech stocks and these digital assets can react to market influences just like equities do.
Periods of wealth accumulation and economic growth may embolden individuals to allocate to emerging asset classes like Bitcoin to generate higher than average stock market returns. The demand is also dependent on the appeal of alternative investments and can increase in countries where their local fiat currency (e.g.,Yen Euro) is rapidly devaluing.
Presently, Bitcoin has dipped below USD$20,000 after hitting an all-time high of USD$69,000 in November 2021. Coinbase, Crypto.com and Gemini announced large-scale lay-offs amidst a sour economic outlook. The rapid decline in the crypto market has mirrored the selloff in traditional markets triggered by rising inflation and a sharp tightening of monetary policy by the Federal Reserve. This has proven that Bitcoin and the crypto market do indeed move in tandem with traditional assets and is not a hedge against inflation as some had previously anticipated or, perhaps, hoped.
Inflation is a rise in prices and this can be translated as the decline of purchasing power over time.
Many advocates of Bitcoin argue that it is a counter-inflationary asset, which means that it will not respond to inflationary pressures like a fiat currency would. This was true to a certain extent as countries like Turkey and Nigeria saw disproportionate Bitcoin adoption in early 2021 due to high inflation and lack of faith in the Lira and the Naira respectively. By holding Bitcoin, locals increased their purchasing power as the price of Bitcoin climbs while their fiat currency depreciates. In contrast, the opposite can be said as well. Inflation has reached 40-year highs and to date Bitcoin has depreciated more than two-thirds of its all-time high value.
While inflation does not affect Bitcoin directly per se, it typically leads to higher interest rates which have a trickle-down effect ultimately causing a slump in risk-on asset prices.
There are many methods used to control inflation and, while none are definite bets, some have been more effective and inflicted less collateral damage compared to others. Today, contractionary monetary policy is a more popular method of controlling inflation, which is to reduce the money supply within an economy by raising interest rates. In doing so, credit becomes more expensive, hence reducing consumer and business spending which results in a downturn in economic activity.
The Federal Reserve generally responds to inflation by increasing its benchmark interest rate. This customarily reduces the demand for speculative investment assets as debt-based securities become more valuable. This typically slows down investor activity overall by making liquidity more expensive.
It is much easier to invest in alternative assets like crypto in an epoch of cheap money and high liquidity. One of the prevailing theories on how crypto grew exponentially is that investors had idle funds and few better alternatives. These trends will likely change as the Fed raises its federal funds rate. This will inevitably affect the price of Bitcoin along with most other assets.
The Federal Reserve tends to keep interest rates within the sweet spot of 2% to 5% which helps to maintain a healthy economy. However, there have been times when interest rates are well above that range to curb runaway inflation. This means that the cost of borrowing is much more expensive, and there will be lesser borrowers in the market eventually. In turn, this detrudes investors’ risk appetite, inducing them to invest in safer traditional assets such as cash, high-yield savings accounts and treasury bonds.
Risk-On Vs Risk-Off Conditions
When interest rates were kept near zero from 2008 to 2016 due to the Global Financial Crisis and from 2020 to the start of 2022 due to Covid-19, investors were more willing to take on more investments in search of a higher reward.
Bitcoin has experienced a lot of volatility and price appreciation since its inception in 2009. It was trading at just $0.09 on the 1st of January 2010. At present, that’s almost a 223,000x increase. Due to Bitcoin’s volatility, the cryptocurrency market in general is aligned with risk-on market conditions.
A risk-on environment captures positive investment sentiment where investors use their capital to purchase Bitcoin and other high-yielding instruments. Bitcoin, being the new and emerging asset class, has captured investors’ interests during the bull run. As a result, we have seen enormous gains in Bitcoin in 2021.
Conversely, during risk-off conditions, investors attempt to minimise risk by investing in assets with more predictable returns. Risk-off environments can be caused by widespread corporate earnings downgrades, slowing economic growth and many other factors. Risk-off assets like currencies and bonds have been gaining popularity of late as we see a huge de-risking event unfold. US treasury yields have been surging amidst the tumultuous market environment. During such conditions, investors seek safe haven assets as they want to avoid risk and are averse to it.
Is Bitcoin a better investment?
Due to its scarcity similarly to gold, Bitcoin has great characteristics to act as a store of value, and can eventually become a risk-off asset like gold when it is more established and its supply dwindles exponentially due to the future halving events.
It is important to bear in mind that the crypto market can be affected by a myriad of factors simultaneously. Given its present correlation with the equities market and how the price has reacted to interest rate hikes, it is crucial to pay attention to the macro environment and how the Fed is handling interest rates to make the best-informed decisions.
As an emerging asset class, Bitcoin has still outperformed many other traditional assets till date. For those with a long term view, it could also be a good time to slowly accumulate Bitcoin in an environment where fear is abundant in the market. Afterall, accumulating Bitcoin at the current market price is better than buying when Bitcoin was at US$ 68k tops yeah?
If you are new to digital assets, it is important to work with a fund manager with crypto experience if you need help determining when to invest. Regulated by the Monetary Authority of Singapore, Fintonia Group is a Singapore-based fund manager offering two institutional-grade Bitcoin funds — Fintonia Bitcoin Physical Fund and Fintonia Secured Yield Fund. These funds were designed with the intent to help professional investors manage the security, legal, and financial risks within the fast-growing crypto ecosystem..