Risk-off came to the crypto world on the weekend as all cryptocurrencies took a sudden tumble. Bitcoin fell as much as 20%. Prices slightly recovered and steadied, but all major coins suffered significant losses.
How should investors analyze the crypto crash and what does it mean for equity investors and other risk assets.
Asset return profile
Will there be any fallout from the crypto crash? A MAN Institute study
of cryptocurrency asset returns found that cryptos are uncorrelated with other asset classes.
While overall correlations are low, the researchers also found higher correlations during periods of equity drawdowns.
In the 6% of instances where the equity market sold off 5% or more over a one month period:
- The average performance of Bitcoin was -13%;
- Bitcoin registered a negative return 86% of the time
- The left tail correlation was 0.3.
Although these statistical studies are interesting, they don’t tell the entire story.
Profile of a crypto investor
To fully analyze the possible fallout of crypto volatility, it’s important to first understand the demographic profile of a crypto investor. A recent Pew Research survey
found that “16% of Americans say they have ever invested in, traded or used cryptocurrency”. A closer examination found that crypto investors and traders are mostly young and male. 43% of men ages 18 to 29 are or have been crypto participants. The next largest demographic group are men ages 30 to 49.
Crypto bros ~ YOLO speculators
While they don’t exactly overlap 1 to 1, the young and male demographic is highly similar to the “get rich quick” and “you only live once” (YOLO) psychology Robinhood traders. It is therefore not surprising to see the high correlation between the price of Bitcoin as a proxy for the crypto complex and the relative performance of the ARK Innovation ETF.
Similarly, the performance of meme stocks as measured by BUZZ is also highly correlated. From a factor perspective, this is all the same trade. Investors should also distinguish between speculative growth and large-cap high-quality growth, as measured by the NASDAQ 100. Speculative growth is breaking down against both the S&P 500 and NASDAQ 100 FANG+ stocks, which are cash generative and enjoy strong competitive positions.
A sentiment-driven explanation of last weekend’s crypto crash is Crypto.com’s purchase of naming rights to the now “Staples Center” in Los Angeles. A macro explanation is a deceleration in global liquidity, as measured by changes in M2 money supply, which has shown a rough but uneven correlation with Bitcoin prices. The recent hawkish pivot by central bankers around the world is likely to put downward pressure on crypto assets. Add to the mix the 5x and 10x leverage available to crypto traders in offshore markets, downside volatility episodes such as the one this weekend is not a surprise. If leveraged crypto traders need to sell other assets to meet margin calls, the most correlated assets are speculative growth equities, as evidenced by the poor performance of ARKK today.
A Christmas present under the tree?
I suggested yesterday that small-cap stocks are beaten up and could see further selling pressure during the tax-loss selling season, followed by a rebound in late December and January (see In search of the next bearish catalyst
). An even more speculative play for traders would be speculative growth stocks, as represented by ARKK and BUZZ, later this year. If leveraged crypto traders are forced to liquidate their stocks to meet margin calls, expect further selling pressure in the coming days, followed by a rebound soon afterward.
For small-cap investors, this means the lower quality Russell 2000 should lag the higher quality S&P 600 in the first half of December, followed by a relative relief rally.