30 Mar 2023

Correlations are declining - And it makes sense!


In Short

This article points to several forces leading correlations to naturally decline between BTC and traditional markets. In essence, no natural long-term relationship to interest rates worsened liquidity, structural changes, and behavioral patterns all contribute to the current paradigm.


  • BTC's 30 day correlation with Nasdaq sits at 0.3, down from 0.75 in October
BTC's 30-day correlation to Nasdaq currently sits at 0.30, down from 0.75 in October. Why?1. BTC was very sensitive to hikes in the short term *NOT* necessarily sensitive in the long term. 2. Smaller mcap, more risky to use in hedges 3. Liquidity 4. Tesla 5. Narrative
Interest rates/Policy effects.
In the zero-interest rate regime of 2020-2021, growth was THE priority. In crypto, the growth focus was perverse. This is the source of the yearlong correlated hangover that was 2022. Public BTC mining companies financed their operations through fiat debt and strived to hold BTC. Rising rates, falling BTC prices, and increasing electricity prices forced miners to sell, leading correlations to grow.
Chart: @samjruleStart-ups with easy access to capital through private fundraising sought growth over everything else - and low-interest rates enabled the circus to escalate. Effects on BTC are most profound by looking at centralized crypto lenders. Genesis, Celsius, BlockFi et al were motivated in part to show growth in their loan books and, in extension, raise funds through various seed rounds at higher valuations. DD and risk management was not a priority.As the cost of capital increased (rate hikes), bad risk management could no longer be solved by private fundraising. Loans were called back. Liquidity was tight. Irresponsible lenders buckled under the pressure.The crypto credit market is now significantly smaller in size. The long-term effects of tighter monetary conditions on public companies are more important than in BTC.An indebted public company will always be exposed to interest rates. This is not necessarily the case for BTC. Bitcoin, simplified, is a scarce digital commodity with a cowboy industry built around its eyeballing growth. In contrast to equities, a fair value/fundamental value of BTC cannot be assessed through DCF models. In sum, hikes had a very profound impact on BTC in the short term due to the overall perverse focus on growth in the industry. Many of these companies are bankrupt, have sold BTC, or have faded into obscurity. The longer-term implications of high interest rates are unknown. 
Hedging BTC through Nasdaq and vice versa.
Alameda hedged their totally irresponsible usage of FTX client money through Nasdaq 100. Highly likely that more crypto funds, and traditional funds did the same.
Alameda went bust. BTC's market cap dwindled, potentially disincentivizing funds from traditional markets to use BTC as a risk proxy. 
Most market makers saw major losses in the past year and have drastically changed their risk assessment of the market. Funds locked in FTX are the most obvious example.See the Folkvang story in Coindesk.Trust has diminished, leading market makers to be far more cautious about holding large size at any centralized exchange.In sum, less liquidity means that the net buyer and net seller has a net larger impact on the general direction of the market.
Chart: @KaikoDataBuyer exhibit 1:A long-term Bitcoin bull view a drawdown of 60-80% from ATH as an attractive point to average into BTC - and an area to avoid selling. These investors tend not to care about the state of the global economy. They want to increase BTC exposure.
Buyer exhibit 2
MicroStrategy bitcoin purchases graph1
Unique bids - Binance rotating $1bn recovery fund to BTC, ETH, and BNB, MicroStrategy purchasing BTC. The net impact of these purchases should not be underestimated in the current illiquid market.
Tesla (Public companies reducing BTC exposure in 2022)
Tesla sold 29k BTC last year. Holds less than 10k BTC. Public miners sold BTC. BTC's natural connection to Nasdaq through companies holding BTC as a corporate treasury asset fell. The only net buyer was Microstrategy.
The narrative - Global banking turmoil sheds light on risks related to bank deposits.
Nasdaq companies and VC companies were severely impacted by SVB. BTC may be custodied independently and bears unique qualities as a SoV in that regard. Looking at granular correlations, BTC has been significantly less correlated to Nasdaq during U.S. hours than earlier this year - and considerably less correlated than during October.
granular correlation
Further, global demand for BTC exposure has grown, with BTC seeing most of its recent upside during European and Asian trading hours.
Rounding up.
Correlations are low due to a myriad of reasons, and momentum is strong. Tightened liquidity means that the net buyer and seller has a larger impact. Long-term net buyers and unique bids in the last month has caused strength. 
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