The entrance of institutional investors into the cryptocurrency market was one of the highlights of 2021. Tesla (TSLA) purchased $1.5 billion in bitcoin (BTC) that year, and Wall Street banks such as JPMorgan Chase (JPM) and Morgan Stanley (MS), as well as hedge funds, began allocating client assets to bitcoin.
These institutional investors not only represented a growing mainstream acceptance, but they also appeared to drive up prices. The sector’s market capitalisation increased by 185% that year.
With the crypto market’s latest plunge wiping off $1.25 trillion from the industry’s all-time high market capitalisation late last year, the question arises: What role is institutional money playing in the crash? To put it another way, are institutional investors making the situation worse?
One thing is certain: the cryptocurrency market is becoming increasingly correlated with the stock market, and institutional investors appear to have exacerbated that correlation. When the stock market falls, crypto falls with it.
“The influx of institutional interest in BTC, which started to pick up in early 2020 with public declarations of interest from stalwarts of traditional investing, such as Paul Tudor Jones and Renaissance Technologies, coincides with a sustained jump in the 60-day correlation between BTC and the S&P 500,” according to an April 2022 report by Genesis Trading.
According to Dow Jones Market Data, the three-month correlation between Bitcoin and Ether (ETH) and the major US stock indexes reached a new high last week.
The painful takeaway for bitcoin bulls is that the recent crypto crash can’t be separated from the downturn in traditional markets.
Stocks are now in a bear market after the Federal Reserve raised interest rates by 50 basis points, or 0.5 percentage points, at its latest Federal Open Market Committee (FOMC) meeting in May.
Both crypto and traditional markets briefly soared after Fed Chair Jerome Powell ruled out a higher rate hike at upcoming meetings, but they quickly reversed course after what Paul Hickey, co-founder of Bespoke Market Intelligence, described as a “reality check.”
The S&P 500 and the Nasdaq both fell nearly 5% the day after the meeting on May 4. Bitcoin fell more than 10% and is now down more than 35% year to date. For market watchers, it’s easy to see how closely they have been travelling in tandem.
According to a recent Morgan Stanley report, institutional investors dominated crypto trades in 2021, with retail investors accounting for only one-third of all trades on the crypto exchange Coinbase.
“Client interest [is] concentrated more heavily onto the two main crypto assets, BTC and ETH,” analysts at data provider VandaTrack wrote. “This matters because, as more institutions await the first results of the White House executive order on crypto regulation and the ETH merge to ETH 2.0, current price behaviour will continue to be driven by TradFi assets.” (ETH 2.0 is a planned upgrade of the Ethereum network, whereas “TradFi” is crypto-industry jargon for “traditional finance” or the “old world.”)
“We think the increased involvement of institutions, which are sensitive to the availability of capital and therefore interest rates, has contributed in part to the high correlation between bitcoin and equities,” the report stated.
Does this imply that the institutional investors that contributed to crypto’s growth a year ago are now contributing to its crash?
“Absolutely,” said Bob Iaccino, chief strategist at Path Trading Partners and co-portfolio manager at Stock Think Tank.
“We could make such an assumption since the market has matured and a larger portion of participants are institutions exposed to both crypto and traditional assets,” said Joe DiPasquale, CEO of BitBull Capital. “With time, it is plausible that we see faster tops and bottoms in the crypto space compared to the prolonged periods in the past.”
“This is the nature of tradable assets,” he explained. “When assets are sold, all assets are sold. Bitcoin has correlated with the Nasdaq for quite a while now. This is no exception.”
It’s difficult to distinguish between institutional and retail inflows and outflows. However, you will occasionally hear from the investors themselves. Miller Value Partners Chairman Bill Miller, known for outperforming the S&P 500 Index for 15 years in a row, sold some of his bitcoin to meet margin calls, noting that you want to sell very liquid assets when times are tough; in this case, bitcoin.
The ‘Coinbase premium’
Coinbase premium is the difference between the price of buying bitcoin with dollars on Coinbase and bitcoin with USDT on Binance.
Analysts in the cryptocurrency market use this figure to determine who is the more powerful force in the market at any given time – institutional investors or retail investors. Coinbase’s user base is thought to be more institutional than Binance’s. If there is a premium, it usually indicates that institutional investors are driving the market higher.
According to CryptoQuant data, the premium recently flipped negative and fell to a 12-month low.
“Usually, there is a Coinbase premium. This means that the bitcoin price on Coinbase is higher than on Binance. This was/is very important, because American institutions and HNW (High Net Worth) were trading mostly on Coinbase. However… in the latest few days it’s negative. This indicates heavy selling on Coinbase Pro!” according to a blog post by CryptoQuant.
“The crypto investor from retail to institutional tend to also be the investor in tech stocks,” said Howard Greenberg, cryptocurrency educator at Prosper Trading Academy. “They tend to be those bullish on technology as a disrupter to current industries, and this crossover and correlation is playing out currently.”
He claims that the connection remains strong even when the market goes into reverse.
“For Institutions it is also easier to liquidate their crypto positions especially with the 24/7 access to their capital than some other positions, so they tend to be the first positions closed out,” he said.
“In the past year-and-a-half, we’ve had new entrants to the digital assets market from the macro hedge fund world,” Jeff Dorman, chief investment officer at Arca wrote in a report. “It’s the players, not the assets, that are correlated.”
