We were watching the Crypto market with great interest during last week’s Terra/Luna meltdown and the precipitous drop in prices that it seemed to have caused. Many Luna investors were wiped out or suffered serious losses, and the ripple effects on other Stablecoins and crypto prices continue. However, Digital Assets were in decline for the previous five weeks, so it was a good reminder that you can’t analyze crypto in isolation, you have to consider the broad macroeconomic backdrop and correlations between asset classes.
The business of forecasting cryptocurrencies by themselves is hard enough. As Matt Hougan and David Lawant of Bitwise pointed out in the 2021 CFA Institute Guide to Cryptoassets:
“Theories about the drivers of Crypto asset valuations are untested and often poorly designed, and they are rarely - if ever – published in peer-reviewed journals. Due diligence efforts from leading consultants are in their infancy, and few people have carefully thought through the role (if any) that Cryptoassets should have in a professionally managed portfolio.”
Combine crypto’s unique market dynamics with the global macroeconomic environment and regulatory landscape, and it reminds us of the movie “Everything Everywhere All At Once”. Crypto and macro are inseparable, especially since the Fed pivoted to fight inflation, rates are rising, financial conditions are tightening, and economic growth is slowing.
Interest rates affect valuations for all risk assets, including growth stocks, corporate bonds, commodities, and crypto. We've learned that both traditional and alternative assets which typically have low correlations can become highly correlated during times of market stress or crisis, like during the housing/credit crisis in 2018 and the COVID market meltdown of 2020, and crypto is proving to be no exception. This often happens because institutional investors, who often employ leverage, have to sell their most liquid assets during big declines, causing selling contagion across asset classes. The events of last week highlight the difficulty of separating the effect that crypto has on macro and macro has on crypto. Please reach out to Hugh or Rich with any questions regarding the current macroeconomic situation and potential impacts on your portfolio.