In recent weeks, cryptocurrencies have traded lower in synchrony with equities. However, in recent days, the steep cryptocurrency drawdown was further fueled by the failure of the Terra blockchain protocol and its UST stablecoin due to a flawed “pegging” mechanism which caused UST to lose its intended $1 peg.
- Rolling 30-day correlations between cryptocurrencies and stocks have recently spiked to new heights with stubbornly high levels of equity market volatility as measured by the VIX index. This is especially true in the relationship between cryptos and more technology heavy indices.
- The collapse of the Terra blockchain and its two native tokens, LUNA and UST, fueled last week’s broader crypto selloff. UST initially lost its $1 peg on May 6. Once its flawed mechanics became apparent to market participants, UST and LUNA each suffered a cascading valuation spiral seeing their combined market value drop from the April 5 all-time high of $58 billion to Monday’s value of just $2.6 billion.
Cryptocurrency markets will now decipher whether Terra’s failure is isolated or systemic in nature. While shockwaves from Terra could be felt in the days ahead, we do not think it is an indictment on the broader digital asset ecosystem. We believe this will accelerate Washington’s regulatory agenda which would be a net positive for investors.
Cryptos follow the equity drawdown
Cryptocurrencies have been caught in the broad downdraft of equities in 2022. More specifically, cryptos have traded in alignment with growth equities which have been particularly challenged as the Federal Reserve (Fed) embarks on tighter monetary policy to combat elevated inflation. This also highlights the sensitivity of cryptos to a macro environment with diminishing liquidity both through Fed policy and the expiration of emergency fiscal stimulus measures we saw during the heights of COVID-19. The chart below illustrates that cryptocurrencies now have the highest correlation to equities in the last several years.
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