A major event in the crypto world in 2021 was the entry of institutional investors into the space. Tesla (TSLA) purchased $1.5 billion worth of Bitcoin (BTC), and Wall Street banks like JPMorgan Chase (JPM) and Morgan Stanley (MS), as well as hedge funds, began investing client money in Bitcoin that year.
These institutional investors were not only a sign of growing mainstream acceptance, but also seemed to drive prices higher. Cryptocurrencies boomed, and the sector's market capitalization rose 185% this year.
Now, as the crypto market's recent slump wipes $1.25 trillion off the industry's record market capitalization reached late last year, the question is: What role is institutional money playing in this crash? Or, to put it another way, are institutional investors making the situation worse?
One thing we do know: The crypto market is increasingly correlated with the stock market, and institutional investors seem to have exacerbated that correlation. And when the stock market crashes, it takes cryptocurrencies with it.
"The influx of institutional interest in BTC, which began in early 2020 with public expressions of interest from traditional investing greats such as Paul Tudor Jones and Renaissance Technologies, has coincided with a continued rise in the 60-day correlation between BTC and the S&P 500," states an April 2022 report from Genesis Trading. (Genesis is a subsidiary of Digital Currency Group, which includes CoinDesk).
The three-month correlation between bitcoin and ether (ETH) and major U.S. stock indexes hit a record high last week, according to Dow Jones Market Data.
For Bitcoin bulls, the fact that the recent crypto crash cannot be decoupled from the downturn in traditional markets is an uncomfortable realization.
Following the Federal Reserve's recent 50 basis point, or 0.5 percentage point, rate hike at the last Federal Open Market Committee (FOMC) meeting in May, equity markets are in a bear market.
Both crypto and traditional markets briefly shot up after Fed Chairman Jerome Powell ruled out a larger hike at upcoming meetings, but they quickly reversed after Paul Hickey, co-founder of Bespoke Market Intelligence, called it a "reality check."
The S&P 500 and Nasdaq both fell nearly 5% the day after the May 4 session. Bitcoin fell more than 10%, bringing its year-to-date loss to more than 35%. For market observers, the result was how closely linked the two markets are.
A recent report from Morgan Stanley found that institutional investors dominated cryptocurrency trading in 2021, while retail investors accounted for just one-third of all transactions on crypto exchange Coinbase, the Financial Times reports.
"Customer interest [is] more focused on the top two crypto assets, BTC and ETH," wrote analysts at data provider VandaTrack, according to the newspaper. ETH stands for Ether, the native cryptocurrency of the Ethereum blockchain. "This is significant as more institutions await the initial results of the White House executive order on crypto regulation and the ETH merger into ETH 2.0, current price behavior continues to be driven by TradFi assets." (ETH 2.0 is shorthand for a planned upgrade to the Ethereum network, and "TradFi" is crypto industry jargon for "traditional finance." The old world, so to speak.)
"We believe that the increased exposure of institutions to the availability of capital, and thus to interest rates, has contributed in part to the high correlation between bitcoin and equities," the report says.
So does that mean institutional investors, who helped the cryptocurrency market boom a year ago, are now a factor in the 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 because the market has matured and a larger portion of the participants are institutions that have exposure to both crypto and traditional assets," said Joe DiPasquale, CEO of BitBull Capital. "Over time, it's plausible that we're seeing faster highs and lows in crypto compared to the long periods in the past."
"That's the nature of tradable assets," he said. "When assets are sold, all assets are sold. Bitcoin has been correlated with the Nasdaq for quite some time now. This is no exception."
It's not easy to separate inflows and outflows between institutional and retail investors. But sometimes you hear from the investors themselves. Miller Value Partners Chairman Bill Miller, who is known for beating the S&P 500 Index for 15 straight years, sold some of his Bitcoins to meet margin calls.
The "Coinbase premium
Take a look at the "Coinbase premium," which is the difference between the price of buying bitcoin with dollars on Coinbase and the cost of buying bitcoin on Binance using the USDT stablecoin.
Crypto market analysts look at this figure to assess who is the bigger force in the market at any given time - institutional investors or retail investors. The assumption is that Coinbase's user base is more skewed toward institutional investors than Binance's. So when there is a premium, it usually means that institutional investors are leading the market higher.
Recently, however, the premium turned negative and fell to a 12-month low, according to data from CryptoQuant.
"Normally, 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) traded mainly on Coinbase. However, in the last few days it is negative. This indicates heavy selling on Coinbase Pro!" said CryptoQuant in a blog post.
"Crypto investors from retail to institutional tend to also be investors in tech stocks," said Howard Greenberg, cryptocurrency instructor at Prosper Trading Academy. "They tend to be the ones who are bullish on technology as a disruptor to current industries, and that overlap and correlation is playing out right now."
The connection apparently continues when the market goes into reverse, he said.
"It's also easier for institutions to liquidate their crypto positions, mainly because they have 24/7 access to their capital, than some other positions, so they tend to be the first positions to close," he said.
"Over the past year and a half, new entrants from the macro hedge fund world have entered the digital asset market," Jeff Dorman, chief investment officer at Arca, wrote in a report. "It is the players, not the assets, that are correlated."