Post-ETF: Time to Short BTC?

With ETF decision out, US macro correlation should hold by 2H24

A Contrarian View: Time to Short BTC

Crypto experienced a robust recovery in 2023 after a dismal year marked by a 60% average loss, outshining other assets on a volatility-adjusted basis (Figure 1). The year was characterized by significant regulatory developments within the industry, replacing the 2022 theme of institutional breakdowns. The legal landscape, from allegations against key crypto exchanges to rulings on exchange offerings and ETFs, presented both challenges and opportunities for digital assets. However, the sector saw progressive regulatory shifts, notably towards a potential Bitcoin ETF approval, fostering optimism throughout the year. Despite irregular crypto price trajectories, the strength of the risk-adjusted returns for digital assets was noteworthy, especially as crypto volatility dipped to multi-year lows at one point (Figure 2). We now focus on several significant topics anticipated to gain attention in the upcoming year.

Theme 1: Macro Matters

There was a substantial shift in crypto correlations despite a prosperous year for equities, gold, and digital assets. Even with specific crypto-related adverse events in 2022, such as the collapse of 3AC, Celsius, and FTX, the correlation between crypto and equities remained relatively stable and the crypto-gold correlation grew more positive, both starting 2023 at a historical high. Justifiable direct relationships emerged, supported by the perception of crypto and equities as risky assets influenced by monetary policy, and crypto and gold as non-interest-bearing inflation hedges that thrive in weaker USD environments. However, a deviation began around March 2023 as fears of a regional banking crisis grew, possibly increasing interest in decentralized finance. The correlation increased in September with the clearer regulatory outlook for crypto following the SEC-Grayscale court ruling, only to decrease lately despite major rallies in both asset classes. The positive crypto-gold correlation remained sturdy as fears of financial crisis decreased, but fell near zero as the anticipation for a Bitcoin ETF approval grew. Although historically crypto had not been an effective portfolio diversifier due to its strong correlation with equities, it has recently gained diversification power due to the shift in market drivers to more individualized stories.

Equities and USD continue to be critical macro drivers, though their relationships with crypto in 2024 remain uncertain (Figures 4 and 5). The relationship between crypto and traditional financial assets is cloudy due to various reasons including potential changes in regulatory frameworks, varying global growth and inflation projections, and potential changes in monetary policies. These factors could significantly affect the performance of risky assets like crypto, especially in the event of a recession.

The impact of crypto risk on traditional financial markets may remain minimal, but the converse might not hold true. Crypto markets, being relatively new, have limited experience with major market events triggering a spillover into larger risk markets. Increased volatility in equity markets often coincided with volatility in crypto prices, but the reverse wasn’t necessarily true (Figure 7). While the global crypto market capitalization remains small compared to other financial assets, the influence of crypto-related crises on wider financial markets should be minimal. However, increased adoption of crypto might further intertwine the worlds of DeFi and TradFi, potentially exposing crypto to crises in global financial markets.

The correlation between crypto and gold ceased its decline, though it remains negative. Amid regulatory changes in the crypto space and fluctuating rate predictions for leading central banks, the crypto-gold correlation saw a sharp dip. However, as easing cycles begin in developed markets, this correlation might see a temporary increase, especially as the US dollar gains strength.

At present, only crypto volatility is above its one-year average. Crypto volatility has risen due to significant events such as the SEC’s approval of spot Bitcoin ETFs (Figure 20). For other financial assets, the market anticipates a relatively smooth landing, leading to decreased volatility. Though 3-month crypto volatility has steadily increased (still subdued historically), equity volatility has resumed its decline (Figure 21). Interestingly, while ETH has generally been more volatile than BTC, this trend has not held since early 2023.