New research model sheds light on cryptocurrency market drivers

The new study has delved into the prices of cryptocurrencies, particularly bitcoin, revealing that markets are significantly influenced by both conventional financial factors and cryptocurrency-specific factors.

The paper by Austin Adams of Uniswap Labs, Markus Ibert of the Department of Finance at Copenhagen Business School and Gordon Liao of Circle Internet Financial was published earlier this week.

✨New research ✨

We teamed up @circle and Copenhagen Business School to explore what drives crypto asset prices, examining the impact of:

+ Monetary policy
+ Broad market risk premium
+ Crypto specific demandhttps://t.co/S0FqJGV7vb

— Uniswap Labs 🦄 (@Uniswap) July 30, 2024

What drives crypto markets?

The researchers used a “sign-restricted vector autoregressive (VAR) model” that allowed them to examine cryptocurrency price fluctuations stemming from spillovers in traditional financial markets versus risks inherent in crypto assets.

The new model split bitcoin returns into several shocks, including monetary policy, conventional risk premium, adoption, and crypto risk premium. He revealed that monetary policy shocks have a substantial impact on bitcoin prices, especially over longer time horizons.

For example, contractionary monetary policy as the Federal Reserve raised interest rates accounted for more than two-thirds of bitcoin’s sharp decline in 2022, when the asset retreated about 65%.

The crypto contagion caused by the collapse of the Earth/Moon ecosystem and FTX at the end of the year also contributed to this huge bear market.

The research noted that while conventional shocks can have large, lower-frequency impacts on cryptocurrency prices, “the majority of daily bitcoin price movements are not explained” by such disruptions.

Bitcoin returns to crash since 2019. Source: Uniswap Labs

He also found that when there is turmoil in the crypto market, people tend to move their money into stable currencies, showing behavior similar to how investors might buy gold or government bonds during stock market turbulence.

When BlackRock announced plans for a Bitcoin ETF, the model detected both increased adoption of the asset class and a decrease in crypto-specific risk aversion. In simple terms, this news made people more interested in BTC and less concerned about its risks, driving the price up.

Crypto is not yet integrated with TradFi

The researchers concluded that while crypto is not completely separate from the broader financial ecosystem, it is not completely integrated either.

Their findings highlight the importance of identifying the drivers of crypto returns and understanding the evolving relationship of the asset class with traditional financial markets.

With a Federal Reserve rate cut expected in September, crypto markets should perform well at the end of the year due to increased liquidity and risk appetite. This also aligns with the four-year market cycle, which should see a bull market peak at the end of 2025…if history rhymes.

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