2021 was a huge year for crypto in many respects. If reports coming from crypto observers are anything to go by, it seemed to be the year of bitcoin entering the mainstream.
However, the huge mainstream breakthrough represents a “double-edged sword”. This is according to a recent report by banking giant Goldman Sachs.
On one hand, valuations will almost certainly rise. On the other hand, crypto seems to be increasingly correlated to the very enemy that bitcoin was created to replace: the traditional financial markets.
In a Thursday note to investors, Goldman Sachs analysts Zach Pandl and Isabella Rosenberg pointed out that the total market cap has dropped by 39% since November. The fall is notable because it was triggered primarily by macroeconomic factors outside the crypto market.
Massive liquidations in crypto have often come on the heels of considerable sell-offs in the equity markets. According to the Wall Street bank, bitcoin has hit its highest level of correlation with the Standard & Poor’s 500. In particular, the flagship cryptocurrency is positively correlated to frontier technology stocks, proxies for consumer risks like inflation, and crude oil, while being negatively correlated with the USD and real interest rates.
“Mainstream adoption can be a double-edged sword. While it can raise valuations, it will also likely raise correlations with other financial market variables, reducing the diversification benefit of holding the asset class,” the note said.
Put differently, the more bitcoin is correlated with legacy markets, the lower the asymmetric profits would be.
The latest crypto market catastrophe came after the U.S Federal Reserve revealed plans to maintain interest rates near 0% as well as to considerably shrink the size of its balance sheet after rate hikes commence. The Fed is also close to doing away with the astounding stimulus given to traditional finance markets since COVID-19 rocked the world in early 2020.
The report further notes that additional developments of blockchain technology, including metaverse applications, might offer a “secular tailwind” to the valuations of a couple of crypto assets in the future. These assets, however, won’t be “immune to macroeconomic forces, including central bank monetary tightening.”
Bitcoin and the aggregate crypto markets have retraced by over 50% from their record-highs. Given the up-and-down in Wall Street, it’s unclear whether they will stay there or recoup their losses.