Thread by @xrpwhitefox87

Crypto Valuations: How stock market correlation came to dominate the crypto risk factors.

A deep dive into the macro economic factors linking #Crypto and #Stocks.

Disclaimer: economics is supposed to be a science but the human aspect provides for a wide variance between models and what happens. I know hindsight is 20/20, but to create better models we most examine what has happened and build for the next market cycle.

This is the continuation of a series of threads in which I dive into the different risk factors and there impact within crypto valuation models.

Today we will dive into the dominating risk factor: Stock market correlation.
cryptos.blue/bitcoin/152194…

This article from Blockworks shares a lot of sentiment shared by #Crypto traders. If Crypto Decouples then the value of the different networks can rise against the dollars and we all get our moon shot.

https://twitter.com/Blockworks_/status/1523787165951348737

Unfortunately the reality is that Stock market to Crypto correlation is increasing and has been doing so since March of 2020.

blogs.imf.org/2022/01/11/cry…

I suggest reading the post as its a quick piece but there two things I felt were key in their findings. The first is the visualization of the increasing correlation up to Jan 2022. The blockworks article linked above provides that this has continued through 2022.

The second is that the increased correlation can lead to a risk "Spill-over". This is where two markets that are correlated start to influence each other in a self referencing cycle. The march 2020 to March 2021 period can be seen as a positive spill-over.

The stock correlation increase was driven directly by crypto adoption by publicly traded companies. Holding, building crypto solutions, creating products to support mining and accepting payments lead to the creation of a number of ETF's with "Crypto" exposure.

The flow of funds from Enterprise level adoption drove the price of #BTC to rise. The value of those companies then rose for their involvement with crypto. Crypto would then rise for how well the stocks are doing. This feedback loop then stuffed itself on cheap monetary policy.

Now we need to factor in how different types of stable coins add or take away to the market correlation risk. Stable coins are a crypto that was designed to have a steady price during settlement. The most popular stable coins are denominated in USD.

Not all stable coins are built the same. They all have different pro's and cons but I am going to simplify it for this discussion. USD denominated stable coins can be separated by their collateral holdings into different categories.

The blog posted below from the IMF explore this concept in terms of systemic risk from October 2021. It presents the need for regulatory action in the space because of the risk presented.

blogs.imf.org/2021/10/01/cry…

US gov bonds, Cash, T bills and Yankee Cd's are all traditionally used as the safe havens. At the end of the day a treasury note for 1 dollar is worth 1 dollar. Even if inflation buys you less with that dollar. The stable coins with the larger % in these assets are safer.

Stable coins backed by Commercial paper, corporate bonds and secured loans are exposed to more risk. They now have corporate default risk as one of they things that could cause their underlying assets to lose value. This can be mitigated in a number of different ways.

Stable coins that are backed other cryptos represent those with the most risk. This can be mitigated by over collateralizing and implementing limits at which minting of the stable coin is no longer allowed. $DJed does a great example of this.

This article from Tokenist was sounding the alarm between the different types of stable coins in January of 2022. The S&P was down 5.3% for the month of January 2022, and it was the first sign that #UST was not collateralized enough.

tokenist.com/on-chain-data-…

Below you can see how the prices of the different stable coins did with the systemic downward pressure. #USDC behaves the way I believe an Ideal synthetic #CBDC should. Every token should be redeemable for 1 USD.

#BUSD is interesting as it seems to be slightly below a dollar in that period while having mainly USD deposits. I am unsure if this has to do with market sentiment to those deposits or if the PAX dollar reserves impact this somehow.

By Now we all know what happened to #UST, the rapid drop in price lead the underlying assets to be perceived as less than a dollar and it started trading off chain below its peg. It seems that #UST had a few things working against it.

1) Fractional reserve banking, it seems it was purposefully under collateralized. 2) It's peg was to $1 worth of Luna not an actual USD 3) Some of the price protection tech isn't complete.

This became a crypto black swan event as #UST is a stable coin in aspiration but its collateral makes it act like a crypto derivative. In bull market, it is easy to mint more and more #UST as people are buying in but as people sale they price of Luna drops.

As the price drops more is needed to cover the 1 USD worth. #UST was exposed to systemic risk as a derivative of Luna which had value derived from the BTC held by the LFG and other individuals involved with the project.

Unfortunately the BTC wasn't enough to prop the price up as the market expected and then tracked the selling of large amounts of BTC into a soft market. Further eroding the rust in the Peg.

We have seen this type of position derail markets before. While I was at JPMorgan the London whale happened, it was described as a tempest in a tea pot and originally as part of the banks hedging strategy.
en.wikipedia.org/wiki/2012_JPMo…

When does Decoupling happen ?

Eventually, right now we are still in the growing pain phase. Fortunately that means we are early and there are many investment opportunities. unfortunately crypto markets tend to be overleveraged because of a lack of liquidity.

For the foreseeable future I expect correlation to continue increasing until #Crypto overtakes #Stocks. Not in market cap but in terms of technological impact and societal influence.

Tokenized stock trading is coming, and it is the first of major institutional adoption events that will be a watershed moments. @ftx is currently testing it in the US.

https://twitter.com/Brett_FTXUS/status/1523718592986238976

More importantly the regulatory frame work is being pushed in the back end. The SEC is pushing for T+1 settlement days in their new rule proposals. natlawreview.com/article/sec-pr….

They have also approved an exchange with blockchain feed for faster settlement.

reuters.com/business/us-se…

#UST might of been a negative that forced government action because of the shared correlation to the stock market. While we have seen coins de-peg before not to see size while people where paying attention.

blockworks.co/secretary-yell…

In conclusion: #BTC and Alts, will not decouple from #Stocks until after tokenized stock trading has been implemented. trading bots, increased investment in the space and derivative products have a compounding effect of systemic risk. A digital economy is coming, it takes time.

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