Key Indicators Leading Change in the Cryptocurrency Market

Cryptocurrency over the past few years has positioned itself as more than just a volatile asset. It has cemented a place for itself in the world of investing as a new asset class, drawing interest from those with a higher risk tolerance. For most, it is now listed among the likes of equities, fixed income securities (bonds), real estate, etc.

The price of cryptocurrencies, led primarily by Bitcoin (BTC), also show connections to the wider financial markets. Using BTC as the delegate for Cryptocurrency, and the S&P 500 ETF (SPY) the benchmark for equities, the relationship between the two asset classes becomes clear.

At its peak in May, BTC-SPY had a .74 beta coefficient, signaling a strong correlation, and even its local bottom on August 15th of .48 signals a moderate correlation. This is important because it means cryptocurrency, like the equities market, is tied to “Smart Money” — those with the power, influence, and capital to move markets. However, because of cryptocurrency’s volatile nature it is a much more risky asset class.

Over the past few months, this has spelled trouble for cryptocurrencies, which have significantly underperformed their stock market counterparts. This is because of changing risk preferences among investors. When perceived risk in investments is high, investors move out of risky investments and towards lower risk options. Depending on the investor, that could mean a move out of crypto and into any number of safer, less risky alternatives, including, but not limited to: stablecoins/cash, historically low-risk stocks like utilities or consumer staples, or even high-grade bonds. As investors rush to safety they leave a trail of red candles in their wake. We have seen this over the past few months as assets have seemed to crumble in favor of less risky options. For instance, SPY — at its lowest — fell about 25%. Meanwhile, BTC and ETH reached lows of nearly 75% and 80% off their highs, respectively.

As a result of this exodus, many people have been left “bag-holding” sharply discounted coins. Unfortunately, this is what happens during risk-off environments. But that doesn’t stop the question from being asked: when will things get better?

From a technical standpoint, there are a few things that need to occur in order to stage a successful recovery in the crypto space. Mainly, Investors' tolerance for risk must increase, which will allow capital to re-enter more risky assets like Bitcoin and Ethereum. Though risk tolerance is subjective on an individual level we can use risk-on/risk-off metrics to garner a broad-based sense of whether risk appetite is increasing or decreasing across the various markets. Structural repairs also need to take place within the context of large-cap coins, specifically BTC. Reclamations of support levels, increases in volume, and momentum shifts all need to take place in order to sustain any prolonged move upwards.

Consumer Discretionary vs. Consumer Staples

The graph of Consumer Discretionary (XLY) vs Consumer Staples (XLP) is a great marker for gauging risk in the equities market. The outperformance of XLY is often a leading indicator for risk re-entering the stock market. Essentially, since stocks are understood to be less risky than cryptocurrencies, one would be hard-pressed to make a case for rising crypto prices without first seeing confirmation via risk appetite in less risky asset classes such as the equities market.

The graph above depicts investors moving away from risk and towards safety from November to May, and now seems to show a possible reversal over the past few months. After bottoming out from May to July of this year, risk seems to slowly be entering back into the stock market. This is theoretically good for the crypto market, but is not nearly enough evidence to justify any significant claims.

Risk-On Assets in the Cryptocurrency Space

Another strong indicator of risk is FTX’s Shitcoin Index: an index of 50 low-market-cap coins. As risk re-enters the market, low-market-cap coins — which tend to be much more volatile than their larger-capped siblings — see an influx of capital, resulting in higher prices. If FTX’s Shitcoin Index sees clear upward movement, it is a sign that investors feel comfortable taking on the additional risk associated with low-cap, high volatility coins.

Currently, this Index is trading below multiple important levels, showing no such signs of investor confidence.

Structural Repairs

As a general rule, the cryptocurrency market follows the lead of Bitcoin. Coins are welcome to outperform or underperform BTC, but it’s rare a coin will buck the trend for a sustained amount of time. Currently, BTC is hovering around a dangerous level right above its December, 2017 highs.

In order to get back to safety and have any possibility of a larger move to the upside, BTC’s graph needs to make some structural repairs. This includes reclaiming key support levels at $30k and in the $46–48k range (at least), increasing volume, and a momentum shift. Increased volume is necessary as it is indicative of an active market and high demand. A reversal in Bitcoin’s current bearish momentum regime, as measured by its RSI, would also signal growing interest and an increase in buying pressure from eager investors.

Conclusion

Though it seems risk is slowly entering back into the stock market, as evidenced by XLY/XLP, there is no confirmation that risk has started to re-enter the crypto markets, nor that any of the structural repairs necessary in BTC are taking place. Bitcoin is still hovering just barely above dangerously low levels, and risk seems to be far from ready from entering the cryptocurrency market.

In order for larger participation, there needs to be higher investor confidence across the board. This requires more volume entering into risky crypto assets like NFTs or low-cap altcoins, which are reliable indicators for market strength and risk preferences. Structural repairs also need to take place, specifically in BTC; recovering important levels of support, increasing volume, and shifting towards a bullish momentum regime are all signs of a healthy or at least healing market.

To bring this topic into contemporary conversation, I am hard-pressed to believe that The Merge, or any other news will be a satisfactory catalyst in light of the array of problems currently faced by the Cryptocurrency market. Broadly speaking, the rest of the market relies too much on BTC to sustain any move upwards without BTC’s participation. Only once these problems begin to resolve will opportunity arise for the larger cryptocurrency market to start the next bull run.

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