Crypto is getting impacted by U.S. monetary policy much more than stocks. While there seems to be multiple reasons for this emerging trend, macroeconomist Tascha Che believes there are sufficient concerns that may underpin future market declines.
The tech investor, who prefers being called just Tascha, pointed to three main factors: rising institutional adoption, massive increase in leverage, and crypto’s dependence on the U.S. dollar as a funding currency and unit of account.
She spoke ahead of what is lining up to be a busy month for crypto and traditional financial markets. U.S. inflation data is set to be released on Tuesday, and the Federal Open Market Committee interest rate hike decision on Sept. 21. Both Ethereum and Cardano will undergo major network upgrades in September.
Crypto and Massive institutional inflows
“Institutional money has more access to leverage and is more sensitive to interest rate/ funding cost changes, leading to larger reactions of crypto prices to macro environment change,” Tascha outlined in a long Twitter thread.
She said corporate money is heavily invested in conventional finance, which leads “to larger spillover from equity markets to cryptocurrency when the former is affected by macro. This is evidenced by increasing correlation between stocks and crypto since 2020.”
Inflows from institutional investors rose from zero to over 70% of the total cryptocurrency transaction volume between 2018 and 2021, according to Morgan Stanley Research. That’s about $385 billion, using Coinbase’s quarterly data as a proxy for the whole market.
Source: Coinbase, Morgan Stanley Research
Estimates suggest crypto prices have become more sensitive to U.S. monetary contraction than stocks over the past cycle – meaning that when the Federal Reserve raises interest rates, it “hurts” the crypto industry “a lot more than equities.”
It is rather ironic, says Tascha, given bitcoin’s [and cryptocurrency’s ] major selling point as a ‘hedge’ against volatility in traditional financial markets, and inflation. To the contrary, crypto has grown increasingly correlated with stock markets in recent months.
This year alone, billions of dollars have exited the crypto markets, consistent with declines in tech stocks on the Nasdaq, as U.S. economic output shrank and the Federal Reserve either signaled or raised rates to curb inflation.
Corporates driving leverage
While Fed chair Jerome Powell indicated in a recent speech that the U.S. economy needed a tight monetary policy to bring inflation under control, Tascha said that a “massive increase in leverage” might mean more volatility for crypto.
She said the advent of decentralized finance in 2020 brought on a surge in on-chain liquidity, causing both leverage and the total sum of money locked in DeFi money markets, liquidity pools and complex yield products to hit the roof.
“Fast growth of crypto derivatives on centralized exchanges also fueled demand for leverage, which was met by new inflows into crypto by predominantly, again, institutional players,” she explained.
And as several crypto companies such as Celsius and Voyager blew up earlier this year, some DeFi die-hards have argued that “if lend/borrow were all done,” that would be safer for the system, as loans would be over-collateralized and programmably liquidated.
But Tascha, the macroeconomist and tech investor, dismissed that as “wishful thinking.”
“Yes, DeFi may be less exposed to certain risks…but it magnifies other risks…which leads to more interconnected protocols and encourages higher overall leverage,” she said, adding:
“Entry of institutional players increases demand and access of leverage in crypto. Higher system leverage increases impact of spillover from equity market and of dollar appreciation. Result is Fed policy and macro environment having even larger effect on crypto than on traditional financial markets.”
The dollar factor
Tascha also discussed the effect of the dollar on crypto markets relative to U.S. monetary policy actions. She said the use of the dollar as the main funding currency and unit of account in the crypto industry was a major weakness.
The dollar is the single biggest fiat currency in the crypto market. Tokens are predominantly priced in the dollar, USD stablecoins account for 95% of stablecoin markets, and lending and borrowing are largely executed in USD stablecoins.
“But crypto is worldwide and most users are outside U.S,” said Tascha, who holds a Ph.D. in Macroeconomics.
“When USD appreciates, tokens become de facto more expensive for non-U.S. investors whose purchasing power is based in other fiats – reducing inflow into cryptocurrency market mechanically.”
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