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Beware of the TradFi Bear

Beware of the TradFi Bear

Explainers Essentials

09 Feb 2022

The crypto market has been printing red candles relentlessly since the sell-off that began in November 2021. The global market value of digital assets has practically halved, going from $3 trillion to $1.5 trillion in a matter of weeks. It’s nothing new for a market notorious for its volatility that can make even the most dedicated diamond-handed HODLers clench their fists, hoping that lump of coal does indeed shine when the time is right.

But what makes the recent downturns different from the previous ones is a perceived closer relationship between digital assets and traditional markets. This time, the sell-off may have far more to do with traditional macro-economic factors such as inflation, planned interest rate hikes projected for later in the year, and a coinciding sell-off in the traditional stock market.

But wasn’t the crypto market supposed to act as a hedge against inflation, central bank policies, and the rot of fiat currencies eating away at the global economy and household wealth?

R U Still Down?

Now up and at 'em it's on, Bitcoin was made to be strong

And Satoshi told me to be a hedge, since the day I was born

I came up, out the financial gutter never changed my style

Got for real about my whitepapers, 'cause the game was wild

And the fame was a plot to try to change me

And what's strange is, nobody knew my name 'fore it came

Now the whole world is calling me the boomercoin

All I ever did, was try to reach the kids with the real

  • Tupac Shakur, R U Still Down, 1997, Re-Adapted

It is widely said that crypto markets do not move in tandem with traditional financial markets, and Bitcoin specifically acts as a hedge against inflation - like a more advanced future-ready digital gold. That immunity against inflation has been one of the primary appeals of crypto as a safe haven from central bank fiat schemes. Just last October in 2021, JP Morgan Chase said in a note to clients that institutional investors are putting cash into Bitcoin as a better inflation hedge than gold. In the case of BTC specifically, that rationale is supported by the fixed supply of 21 million bitcoins, scheduled halvenings that reduce mining yield, and the consequent scarcity influencing the value more so than macro-economic factors.

However, what we’ve seen recently seems to show that the crypto and TradFi worlds are more related than we think. The ongoing crypto sell-off appears very much related to high rates of inflation. US inflation hit 7% in December 2021, the highest annual rate since 1982. The uncertainty around the current inflationary period, and talk of several interest rate hikes in 2022, has already been reflected in traditional markets as the S&P 500 and the Nasdaq fell 10% and 16% respectively from their 52-week highs in December 2021.

It’s a risk-off dynamic, and while crypto has historically been less affected in such a climate, it seems that this time digital assets are very much part of the broader sell-off. But why? Well, it’s more than likely that what we have seen in the last few months is the other side of the coin when it comes to institutional adoption.

Under the Institutional Influence

For years, we’ve been waiting for the institutions to come out and play in the crypto sandbox, pumping our bags all the way to the moon and back as they funnel their trillions into the next evolutionary step of finance. Well, by and large, the institutions did come around to investing in crypto markets in the last two years - albeit slowly and cautiously. We have transitioned from hesitant discussions about family offices and trillion-dollar asset managers to soaring demand for tailor-made investment products. And right now, the conversation centers around easy access to crypto and DeFi built on regulated infrastructure.

A recent study published by Fidelity Digital Assets that surveyed institutional investors showed 52% of respondents were currently invested in digital assets, with 9 in 10 indicating they were actively exploring opportunities. Many of the barriers that once held institutional adoption back have fallen. The digital asset market is now equipped with institutional-grade custody and infrastructure providers, regulatory frameworks that provide a greater degree of clarity, and a growing DeFi ecosystem that innovates at an incredible pace.

Altogether, this has fuelled the dramatic rise of crypto markets but it also connected it to the dynamic of traditional markets. Facing inflationary conditions as we do today, and the Fed in the US making all the right noises to signal a rotation out of growth stocks, institutional investors tend to sell many of their holdings as part of a risk-off play. And when that happens, they do so across asset classes and won’t hesitate to cut losses. End-of-year targets for wealth managers may have also had a role to play here when it comes to the timing of the broader sell-off.

Lastly, it should also be taken into consideration that crypto markets are maturing in terms of utility. Therefore, the whole market represents a broader investment thesis into technology - similar to tech stocks as a segment of the equity market. Instead of the gold-like store of value play of Bitcoin, investing in Layer 1 tokens such as ETH, SOL, BNB, LUNA, FTM, and AVAX is a technology bet on the wider digital asset ecosystem and its innovative applications. Many institutional investors are increasing their exposure to digital assets, and after BTC, the next logical stop is mostly Ethereum (ETH), followed by the rest of the Layer 1 alternatives. While this is good news for the market cap of the crypto market, it also further intertwines crypto with the TradFi market and the cycles it goes through.

It’s going to be interesting this year to see how this plays out.

Bridging the Gap between Traditional Finance and Crypto

It could be that the two worlds remain closely connected. Traditional finance and the cryptocurrency world could follow the same general direction as macro-economic factors influence decisions made at the institutional desk, with crypto markets going higher or lower than tech stocks as the more volatile cousin of TradFi.

Then again, we need to factor in the regained power of OG crypto whales as institutional players lean in to fear and sell their bags to the diamond-handed. Additionally, a potentially massive wave of new users initiated into crypto via the GameFi-to-DeFi-to-Bitcoin route - as the metaverse comes to life - could further take away the pull of TradFi cycles. Lastly, crypto already has a cycle built-in as BTC halves every 4 years or so, which time and again has proven way more powerful than the growl of the TradFi bear.

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