What’s happening to the crypto market?

Dow Jones crashed after the Federal Reserve raised rates by half a percentage point. Then, Bitcoin followed.

Now, it becomes more and more clear that the times when Bitcoin was a safe haven for investors seeking a hedge against inflation are gone. Before the pandemic, Bitcoin was a non-correlated asset, but it changed with a broad institutional adoption and an influx of rookie investors. As a result, the correlation between equity and crypto markets grew to record levels.

Coinbase chart featuring correlation matrix of macro factors.
Correlation matrix of macro factors. Source: Bloomberg and Coinbase

By the time of writing, Bitcoin had dropped by 10%, trading below $36,000. Ethereum saw a similar decline, changing hands at $2,600. Most blue-chip altcoins are also trading in the red zone, led by Ripple's XRP and Terra’s LUNA.

The heatmap of crypto market at the time of writing
The heatmap of crypto market at the time of writing. Source: Tradingview

As crypto went mainstream, more public companies were willing to add it to their reserves. Tesla, MicroStrategy, Galaxy Digital, Coinbase, and Block are among major firms that hold billions of dollars worth of Bitcoin and other digital assets. Additionally, many tech businesses embraced crypto by integrating payments, minting NFTs, and introducing utility tokens, pegging its price to the Big Tech’s stock market. Following this unprecedented adoption, crypto started performing more like a traditional high-risk asset.

As Fed raises rates, low-risk financial instruments become more attractive to investors. For instance, inflation-adjusted US saving bonds approach a 10% annual yield. Naturally, many investors would abandon their high-risk assets in favor of such instruments. That poses a hidden risk for the crypto market as the fragile equilibrium of algorithmic stablecoins comes under threat.

I have already covered the topic of algorithmic stablecoins and the risks behind this new type of crypto asset. Long story short, a carefully crafted mechanism of a stablecoin and its underlying token may break when users start selling both assets at the same time. Currently, algorithmic stablecoins attract investors through lucrative staking yields, which are heavily subsidized. For instance, Terra offers a nearly 20% lending rate, while the recently launched USDD by TRON outbid it with a striking 30%. However, if one day investors decide that 10% guaranteed by the federal government is better than 20% from an unstable protocol, algorithmic stablecoins may fall into a nice death spiral and drag the whole market down.

Some experts expect that the recent rate hike won’t be our last in 2022. The ongoing Russia-Ukraine war has already driven huge commodity prices, namely crude oil, wheat, nickel, cotton, and natural gas. The conflict is set to cause “the largest commodity shock,” the World Bank warned in its forecast. To curb skyrocketing prices, governments across the world would have to tighten their monetary policies.

Long-term holders, however, can rest easy. In fact, there’s a perfect opportunity to use market volatility and buy the dip. “The plethora of intersecting macroeconomic factors is putting pressure on nearly all risk assets, although we could soon be entering a consolidation phase that would open up more opportunities for crypto in 2H22,” the Coinbase Institutional monthly report reads.