One word has been the main point of discussion over the past couple of weeks, either in traditional finance or in crypto markets: Evergrande.
Macro Uncertainty Drags Down Crypto
This news has influenced the macro perspective of many investors around the world, who fear that its collapse could have a domino effect over the Chinese economy and end up affecting markets all around the globe (most importantly in the U.S. market, which is China's biggest trade partner).
Investor positioning started to be bearish as more and more news about the situation started to hit the media. A moderate sell off started already in the weekend, in part influenced by the weak price action of the last week over most markets.
Monday morning, the markets opened in red and the sell-off increased, with the crypto markets following and falling considerably. Bitcoin dropped from the $47,000 price mark that was holding during the weekend to $42,300 at the start of the day. The selling pressure increased as soon as the bell rang in the U.S. market open, dragging down Bitcoin to a low of $40,000 in spot markets along the day, accounting for a total of a -15% correction since the start of this week.
Since then, the market has bounced back to the $43,000, where it is hovering now:
Ethereum reacted in a similar way to Bitcoin, dropping from the $3,500 price mark of the weekend to a lowest of $2,800, which would sum up as a correction of a -16% since the start of this week. The price has recovered as well to the psychological resistance of $3,000:
As it is well known among crypto investors, both Bitcoin and Ethereum price action have a high correlation between each other. This means that these two asset prices vary similarly both in the upward movements as in the downward movements. It can be observed in the next chart how its correlation trend to be way closer to 1 than to 0:
Seasoned investors always try to minimize the correlation between the assets of their portfolio. This is a practice that improves diversification, since negative market movements will not impact the whole portfolio as much and market sell-offs are slightly more mitigated.
Not only do cryptocurrencies have high correlation between them, but they also show a high correlation with certain traditional market assets as well. The recent crypto market price action has been led by traditional markets activity, so it is useful to be aware of the correlations that historically crypto markets have had with traditional markets.
The next chart shows the correlation of BTC and ETH with major Western indexes:
As can be seen, correlation oscillates between values of -1 to 1. A correlation coefficient close to 1 implies a strong correlation, so a positive price movement relationship between the two prices. A correlation near 0 suggests no correlation and a correlation close to -1 points to a strong negative correlation (meaning that the price of Bitcoin and the asset in question tend to move in opposite directions).
Both charts show how the correlation with Ethereum and Bitcoin is high with the major U.S. index (S&P 500, Dow Jones or Russell 2000), or other major index like the German DAX index, for the case of Bitcoin. On paper, this means that price movements in these index have a high probability of affecting Bitcoin and Ethereum similarly.
This correlation with finance from traditional markets has been increasing as more institutions choose to invest in cryptocurrencies. When the market experiences a sell-off, the portfolio of these institutions need to be rebalanced (often done automatically by algorithms), with the goal of maintaining a constant percentage of each asset relative to their whole portfolio. Furthermore, there is another reason that worsens the situation: cryptocurrencies are considered in finance as a riskier investment vehicle than other traditional finance products due to their high volatility:
This is a factor to consider amid a sharp market sell-off, since investors are more willing to reduce exposure to riskier assets than to assets that behave relatively steady. This behavior acts as a feedback loop, and cryptocurrencies end up usually suffering sharper discounts than other less volatile products.
The lesson learned this time is that it is worth keeping an eye out of the crypto ecosystem and being aware of global events that shake the traditional finance markets like the recent one of Evergrande. These have a considerable effect in the whole crypto markets as well, and this time the event was not led by sudden news but by a series of events that have been developing for weeks. Risk management techniques can be taken into account in anticipation of a similar event, expecting that it could have a high probability of impacting traditional financial markets.
Despite the uncertainty that still persists on the global markets, the macro view of cryptocurrencies continues to be positive. Inflation continues to be relatively high, and cryptocurrencies are more and more a staple in the portfolio of investors and institutions alike.
The three month returns of both Bitcoin and Ethereum shows 26% and 42% respectively. These corrections could present an interesting buying opportunity for investors that were still waiting for a deeper market correction, considering that most major cryptocurrencies prices are discounted 30% from their all-time high prices.