Todd Groth is head of index research at CoinDesk Indices. He has over 10 years of experience involving systematic multi-asset risk premia and alternative investment strategies. Before joining CoinDesk Indices, Todd served as head of factor insights at Premialab, an institutional fintech analytics company, and as a managing director at Risk Premium Investments, a systematic multi-asset asset manager. Before RPI, Todd was a quantitative portfolio manager at Investcorp and began his finance career at PAAMCO, a fund of hedge funds, as a manager within the risk analytics group.
Russ Alan Prince: With Bitcoin up ~70% in Q1 of 2023, what drove performance, and what’s changed after the difficulties of 2022?
Todd Groth: There’s never a dull moment in the world of crypto and the start of 2023 has been no exception. Bitcoin (BTC) posted its best quarterly performance in over two years, gaining 68% for the first three months of 2023. Ether (ETH) is up 50% as well, while the CoinDesk Market Index, or CMI—a proxy for the broader digital asset universe—is up 58% in the first quarter.
Breaking down the quarter, we began 2023 with a substantial rebound in investor mood and sentiment during the first weeks of January—a market phenomenon commonly referred to as the “January Effect,” which provided buoyancy for the broad market after a challenging 2022. A choppy February followed although tokens linked to artificial intelligence and cloud computing benefited from positive views of generative AI and ChatGPT. March brought jitters in the U.S. regional bank sector, though this triggered a reassessment of the Fed’s hiking cycle to the benefit of Bitcoin and the detriment of the dollar.
This shift in market expectations around the Fed’s future interest rate path, and an expansion of the federal balance sheet to support regional lenders led to a rebound in investor sentiment and, thus, overall questions surrounding the stability of the U.S. banking system have resulted in a better-than-expected environment for Bitcoin and other digital assets.
Prince: Bitcoin seemed to track growth stocks last year but seems to be different this year. How should Bitcoin be viewed in a broader portfolio context?
Groth: The performance of 2022 can be explained by the sensitivity of “long duration risk assets” to the interest rate on government bonds, after adjusting for the rate of inflation, commonly referred to as “real yields.” They are called “long-duration” assets because they are sensitive to interest rates via the discounting of future growth expectations in prices and cash flow by prevailing market rates of interest.
These assets require price appreciation to generate a real return, as they have little or no current cash flows to support their value, and include growth-oriented equities, cryptocurrencies and precious metals. When a lower-risk alternative investment re-appears in the market in the form of fixed income with a positive inflation-adjusted “real” yield, as it did in 2022, it causes investors to sell assets within this growth asset group and rotate into bonds and short-term fixed income.
So far in 2023, it appears we’re bucking the 2022 “rising real yields” narrative, which caused investors to rotate out of long-duration risk assets. Real yields peaked in Q4 of 2022 alongside the U.S. dollar and now correlations between bitcoin and 1) gold and 2) developed market currencies have strengthened, suggesting that bitcoin has regained consideration as “digital gold” and a useful hedge against currency debasement. From the perspective of a digitally scarce asset like bitcoin, these are all encouraging developments and help reaffirm bitcoin as an asset with the potential to provide both a fiat currency hedge and a call option-like payout profile.
Prince: Crypto markets are known for being cyclical. What evidence is there to support that and have we sprung forward out of “crypto winter?”
Groth: Digital assets generally tend to do best when they trade according to their own narrative—say like Bitcoin’s inflation hedge thesis—and decouple from the factors and themes driving traditional asset classes. We estimate one-third of Bitcoin’s gains in March were due to these overlapping macro themes, namely the reduction in future interest rate expectations, which are now significantly dovish versus the Federal Reserve’s forward projections.
If inflation remains persistent and elevated, the Fed will have to push back against these dovish market expectations with future hikes, potentially triggering a redux of 2013’s "Taper Tantrum" and an unwind of these gains. If the unexpected increase in rate hikes causes real yields to return to their consistent march higher as we saw in 2022, we would likely re-emerge back into a 2022 market environment, albeit a more benign “crypto winter” period as there is now less leverage in the crypto ecosystem than pre-2022.
Unlike the seasons, and much like a recession, it’s hard to identify when we’ve entered or exited a “crypto winter” until after we have transitioned states and have the benefit of hindsight. It can also be difficult to determine whether recent market trends are the result of a bear market “relief rally” from unbalanced investor positioning or truly the beginning of a new bull market. Our research has found that it can be more useful to study and monitor the momentum in price trends than to focus on current market prices as an indication for crypto seasons. As a result of this research, we have recently launched the Bitcoin Trend Indicator on our website to help assist investors in assessing and navigating the crypto seasons through a simple and transparent methodology.
Liquidity in crypto markets has dropped with trading volumes post-FTX. Until prices rise enough to reignite interest from traders who exited the market in 2022, we don't expect it to improve. With U.S. regulatory action against exchanges and the closure of a number of banks providing crypto on-ramping services, additional hurdles remain for capital entering into the digital-asset market these days.
But it’s unlikely we are heading for a halcyon redux of 2021’s crypto bull market
The U.S. regional banking concerns and the rapid unwind of Credit Suisse have highlighted weaknesses in the traditional financial system when interest rates rise. While this may come to the delight or amusement of crypto maximalists and critics of the fractionalized banking system, it is a source of further deleveraging contagion risk.
Most digital-asset investments share a broader portfolio with traditional public and private-asset markets, with capital allocation decisions within these portfolios linking these disparate markets together through relative value choices which promote and drive correlations across markets. Crypto cannot sail alone.
Russ Alan Prince is the executive director of Private Wealth magazine and chief content officer for High-Net-Worth Genius. He consults with family offices, the wealthy, fast-tracking entrepreneurs and select professionals.