What Drives Crypto Asset Prices?

Institutional Crypto Research Written by Experts

A new research paper "What Drives Crypto Asset Prices?" by Austin Adams, Markus Ibert, and Gordon Liao investigates the factors influencing cryptocurrency returns using a structural vector auto-regressive (VAR) model.

The paper significantly validates the core principles underpinning 10x Research's approach to analyzing crypto markets. Our emphasis on market structure, encompassing various forms of risk premia, monetary policy, and liquidity, aligns with the identified key drivers of crypto asset prices. This robust foundation, combined with historical quantitative analysis and our interpretation of forward-looking events and outcomes, forms the bedrock of 10x Research's methodology.

Here are the key findings and lessons:

Key Findings:

Influence of Conventional Factors:
- The study reveals that crypto asset prices are significantly impacted by conventional risk and monetary policy factors.
- Contractionary monetary policy accounted for over two-thirds of Bitcoin's sharp decline in 2022.
- Since 2023, the compression of crypto risk premia has been the predominant driver of crypto returns, independent of the buoyant equity market backdrop.
Drivers of Bitcoin Returns:
- Bitcoin returns can be decomposed into three main structural shocks: conventional monetary policy shocks, conventional risk premium shocks, and crypto-specific demand shocks.
- Positive conventional risk premium shocks and accommodative monetary policy supported Bitcoin prices in 2020.
- In 2022, the decline in Bitcoin prices was driven by negative monetary policy shocks and negative Bitcoin demand shocks, despite declining conventional risk premia continuing to support prices.
Crypto-Specific Factors:
- Crypto-specific factors, such as adoption and risk premium shocks, play a dominant role in explaining the variation in daily Bitcoin returns.
- Crypto adoption shocks reflect changes in the intrinsic value and adoption rate of cryptocurrencies, while crypto risk premium shocks represent variations in the risk compensation demanded by investors for holding crypto assets.
Stablecoins as Safe Havens:
- The study provides evidence supporting the safe-haven property of stablecoins within the crypto asset space. Stablecoin market capitalization tends to increase during periods of market stress.
Event Studies:
- The paper conducted event studies focusing on significant market events such as the COVID-19 market turmoil, the collapse of FTX, and the launch of BlackRock's spot Bitcoin ETF. These case studies highlight the importance of crypto-specific factors in driving cryptocurrency prices and flows during significant market events.

Lessons Learned:

Interconnectedness with Traditional Financial Markets:
- Understanding the drivers of crypto returns requires considering both conventional financial market factors and crypto-specific factors.
- The evolving relationship between cryptocurrencies and traditional financial markets underscores the need for continuous monitoring of both domains.
Impact of Monetary Policy:
- Cryptocurrency prices are highly sensitive to changes in monetary policy, particularly contractionary measures.
- Investors in crypto assets should closely watch central bank policies as they can have significant implications for crypto market dynamics.
Importance of Crypto Risk Premia:
- The compression of crypto risk premia is a critical factor driving crypto returns, highlighting the role of investor risk appetite and market sentiment in the crypto space.
- Future research and investment strategies should account for the varying degrees of risk premia in the crypto market.
Policy Implications:
- Policymakers should consider the significant spillovers from conventional markets to the crypto market when designing regulatory frameworks.
- Understanding the drivers of crypto returns can aid in developing more effective regulatory policies that ensure market stability.
Investor Strategies:
- Investors should be aware of the distinct factors driving cryptocurrency prices and their potential diversification benefits relative to traditional asset classes.
- The insights from this paper can help investors better hedge their portfolios and manage risks associated with crypto assets.

Future research could extend this analysis by incorporating a wider range of cryptocurrencies and exploring the impact of regulatory changes on cryptocurrency markets. Additionally, developing more sophisticated models that capture the time-varying nature of the relationships between cryptocurrencies and traditional asset classes could provide further insights

You can download the paper here.