What Drives Crypto Markets?

The new study has delved into cryptocurrency prices, particularly bitcoin, revealing that markets are significantly influenced by both conventional financial factors and crypto-specific factors.

A new study has examined the factors influencing cryptocurrency prices, focusing on bitcoin and revealing the significant role played by both conventional financial factors and crypto-specific factors.

The study, conducted by Austin Adams of Uniswap Labs, Markus Ibert of the Copenhagen Business School Department of Finance, and Gordon Liao of Circle Internet Financial, was published earlier this week.

The researchers employed a “sign-restricted vector auto-regressive (VAR) model” to analyze crypto price fluctuations stemming from spillovers from traditional financial markets as opposed to risks inherent to crypto assets.

The new model decomposed bitcoin returns into various shocks, including monetary policy, conventional risk premium, adoption, and crypto risk premium shocks. It found that monetary policy shocks have a significant impact on bitcoin prices, particularly over longer time horizons.

For instance, contractionary monetary policy as the Federal Reserve was raising interest rates accounted for over two-thirds of bitcoin’s sharp decline in 2022, when the asset retreated around 65%. The crypto contagion caused by the collapse of the Terra/Luna ecosystem and FTX later in the year also contributed to that big bear market.

The study noted that while conventional shocks can have large lower-frequency impacts on crypto prices, “most day-to-day movements in bitcoin prices are left unexplained” by these spillovers.

It also found that when there is turmoil in the crypto market, people tend to move their money into stablecoins, exhibiting behavior similar to how investors might buy gold or government bonds during stock market turbulence.

When BlackRock announced plans for a Bitcoin ETF, the model detected both increased adoption of the asset class and a decrease in crypto-specific risk aversion. In simple terms, this news made people more interested in BTC and less worried about its risks, driving up the price.

The researchers concluded that while crypto isn’t entirely separate from the broader financial ecosystem, it’s not completely integrated either.

Their findings highlight the importance of identifying drivers of crypto returns and understanding the asset class’s evolving relationship with traditional financial markets.

With a Federal Reserve rate cut expected in September, crypto markets should do well later this year due to increased liquidity and risk appetite. This also aligns with the four-year market cycle, which should see a bull market peak in late 2025 … if history rhymes.

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