As crypto assets continue to carve out a space in the global financial ecosystem, understanding the forces that drive their prices has become more critical than ever. A recent study, “What Drives Crypto Asset Prices?” by Austin Adams, Markus Ibert, and Gordon Liao, takes a comprehensive look at what influences crypto asset prices, particularly Bitcoin. Their findings reveal a fascinating intersection between traditional financial factors and crypto-specific dynamics.
Crypto assets, once seen as isolated from traditional financial markets, are now influenced by a range of factors that also drive stocks, bonds, and other asset classes. This paper takes a unique approach by using a structural vector autoregressive (VAR) model, which is often used in macroeconomics to understand the dynamic relationships between different economic variables. By applying this model to Bitcoin, the authors sought to answer an important question: “What truly drives cryptocurrency prices?”
The Data and Methodology Behind the Analysis
To understand the complex dynamics of crypto asset price movements, the authors employed a structural vector autoregressive (VAR) model. This model allows for the decomposition of Bitcoin’s price movements into various structural shocks, such as monetary policy, conventional risk premium, and crypto-specific shocks. The authors used daily return data from January 2019 to February 2024 for four key assets: Bitcoin, stablecoins (USDT and USDC), the S&P 500, and 2-year Treasury zero-coupon bonds. By analyzing the co-movements of these assets, the authors were able to differentiate between traditional market drivers and unique crypto-specific factors. Importantly, the use of stablecoin market capitalization in the model helped to isolate adoption shocks and risk premium shocks within the crypto space. This innovative approach allowed the authors to dissect how different types of shocks influence Bitcoin’s price movements over time, providing a deeper understanding of its volatility and relationship with traditional markets.
According to the paper, Bitcoin’s price movements can be attributed to three key drivers:
- Conventional Monetary Policy Shocks: Just like stocks or bonds, Bitcoin is sensitive to changes in monetary policy. When central banks tighten policy, such as raising interest rates, Bitcoin prices often fall, as the opportunity cost of holding the asset increases. For example, in 2022, Bitcoin’s dramatic price drop was largely due to the Federal Reserve’s decision to raise interest rates in response to rising inflation. The paper estimates that over two-thirds of Bitcoin’s sharp decline during that year can be attributed to contractionary monetary policy. This suggests that while Bitcoin is often seen as an independent, decentralized asset, its price is far from immune to the broader financial environment. When central banks act, the ripple effects are felt not only in traditional markets but also in the world of crypto.
- Conventional Risk Premium Shocks: These are “risk-off” moments when investors pull back from risky assets and flock to safer investments. The paper found that these shocks can cause declines in both traditional markets and Bitcoin, though they tend to have a larger impact on Bitcoin during extreme market events. For example, the authors found that during events like the COVID-19 market turmoil in March 2020, investors flocked to stablecoins as a safe haven. While Bitcoin’s price dropped, stablecoin market capitalizations surged, underscoring their importance within the crypto ecosystem. Interestingly, since 2023, compressed crypto risk premia have been the primary driver of Bitcoin’s returns, signaling that investors see less risk in holding Bitcoin, particularly as institutional players like BlackRock enter the space.
- Crypto-Specific Shocks: Finally, there are factors unique to the crypto world. The paper identifies two types of crypto-specific shocks: adoption shocks, which reflect changes in the acceptance and use of crypto assets , and crypto risk premia, which are the returns investors demand for holding such a volatile asset. For example, the collapse of the FTX exchange in November 2022 resulted in negative adoption shocks and increased crypto risk premia, pushing Bitcoin’s price lower while stablecoins gained briefly. The announcement of BlackRock’s Bitcoin ETF marked a significant adoption shock, boosting Bitcoin’s price and reducing the risk premium investors demanded.
These events demonstrate how Bitcoin and other crypto assets are sensitive to both internal market dynamics and external developments in the financial world.
The research presented in this paper underscores that crypto assets like Bitcoin are continuously getting interconnected with conventional markets, responding to the same forces that drive stocks, bonds, and other asset prices. However, the unique dynamics within the crypto ecosystem—particularly adoption shocks and risk premia—add layers of complexity that investors and policymakers need to understand.
