Hardcore Interpretation: What Exactly Is Influencing Bitcoin Prices?
The analytical thoughts and viewpoints of top institutional leaders are worth a look.Author: Deep Tide TechFlow
The price changes of Bitcoin are a barometer for the entire cryptocurrency market.
When the price rises, other crypto assets often rise together, and vice versa.
Thus, predicting Bitcoin price changes and analyzing the factors that influence its price have become the "monthly posts" in crypto news; whether the predictions are proven wrong or right, perhaps no one takes these wild analyses seriously.
As such analyses gradually devolve into providing only bullish sentiment value, serious scientific discussions on "what factors actually influence Bitcoin's price" have become a scarce and high-threshold endeavor.
However, the big players always step in.
Recently, a lengthy paper titled "What Drives Crypto Asset Prices was released, discussing the factors influencing Bitcoin prices using scientific econometric models, and the authors are quite reputable:
Austin Adams: Researcher at Uniswap and Variant Fund;
Markus Ibert: Former Federal Reserve economist and finance professor;
Gordon Liao: Chief Economist at Circle and former Federal Reserve economist.
The analysis and viewpoints from these top institutional figures are certainly worth a look. However, considering the length of 39 pages and the various complex mathematical calculations within, Deep Tide Techflow has distilled and interpreted the paper, attempting to convey its core viewpoints in a more accessible manner, providing references for everyone to grasp market price trends.
TLDR, Key Conclusions
Traditional factors influence the crypto market: Bitcoin's price is influenced not only by internal factors of the crypto market but also significantly by traditional financial market factors (such as monetary policy and risk sentiment).
Dual role of monetary policy: In 2020, the Federal Reserve's loose monetary policy drove Bitcoin's price up, while tightening policies in 2022 led to a sharp decline in prices. Among all factors influencing the price drop, the impact of tightening monetary policy accounted for two-thirds. Without this policy change, Bitcoin's returns could have been higher.
Impact of risk premium: Since 2023, the returns of crypto assets have mainly been driven by the compression of risk premiums (investors' perception of risk for BTC has decreased, leading them to accept lower excess returns), indicating a change in the market's risk assessment of crypto assets.
Complexity of daily fluctuations: Factors such as crypto adoption and risk premiums play a dominant role in explaining the daily return variations of Bitcoin, while the influence of traditional monetary policy is more evident over the long term and has little impact on daily fluctuations.
Impact of specific events: Case studies such as the COVID-19 market turmoil, the FTX collapse, and the launch of BlackRock's spot ETF confirm the short-term impact of specific events on Bitcoin's price.
Methodology for Factors Influencing Bitcoin Prices
When asked how much a new asset class's price fluctuates, you actually need to look at two parts—how much is due to spillover effects from traditional financial markets, and how much is caused by the asset's inherent specific risks.
To explore this issue, the paper analyzes the daily return series of three assets:
Bitcoin: Representing cryptocurrencies.
Two-year zero-coupon Treasury bonds: Representing traditional safe assets.
S&P 500: Representing the overall performance of the U.S. stock market.
In fact, the prices of these three assets change over time, and the next step in this research is very clear—comparing the co-movement of the daily return rates of the three assets, which simply means that multiple assets' return rates show similar upward or downward trends over the same period.
In the real world, we can intuitively feel that BTC prices are evidently correlated with traditional financial markets; the paper rigorously and scientifically abstracts this commonality, forming three specific factors that can influence the prices of Bitcoin and traditional assets:
Monetary policy shocks: Changes in policy from central banks (the Federal Reserve) that affect Bitcoin prices. For example, if they lower interest rates, borrowing becomes cheaper, and people are more willing to invest, which may drive up the prices of assets like Bitcoin.
Traditional risk premium shocks: Influences related to changes in investors' attitudes toward risk. For instance, if most people in the market are worried about risk, it may lead to a decline in the prices of Bitcoin and other assets.
Crypto-specific demand shocks: Changes in demand specific to the crypto market that affect prices. This refers to factors that only impact the cryptocurrency market, such as the emergence of new technologies, changes in regulations, or shifts in cryptocurrency adoption rates and sentiment.
From this perspective, we can further quantitatively analyze how significant each shock factor's impact is and how they influence Bitcoin's price.
Here, we skip the details of the sophisticated mathematical regression analysis model used in the paper and directly look at more understandable analyses and results.
The 2022 Bitcoin Crash: 50% of the Cause Attributed to Tightening Monetary Policy (Interest Rate Hikes)
The paper analyzes the factors influencing Bitcoin's daily prices from January 2019 to February 2024.
Bitcoin's returns can be decomposed into three structural shocks: monetary policy shocks, traditional risk premium shocks, and crypto demand shocks. (Note: You can simply understand shocks as the influence of XX factors on Bitcoin's price.)
These shocks have different impacts on Bitcoin's price over different time periods.
- Market Turmoil in March 2020:
During the market turmoil triggered by COVID-19, traditional risk premium shocks were the main reason for Bitcoin's price decline.
Bitcoin's price fell from $8,600 to $6,500, a decrease of 24.2% (simple return) and 27.7% (log return).
Figure: The black line shows the daily return rate of Bitcoin after mathematical logarithmic processing, while the heights of the other colored lines indicate the contributions of different factors to the return rate.
- Recovery in 2020:
- Subsequently, the rise in Bitcoin's price was supported by a decline in traditional risk premiums and loose monetary policy, but a portion of the increase could not be explained by traditional factors, reflecting a significant crypto demand shock.
- Price Decline in 2022:
In 2022, the decline in Bitcoin's price was mainly caused by negative monetary policy shocks and negative crypto demand shocks, while the decline in traditional risk premiums continued to support prices.
From January 2022 to January 2023, Bitcoin's logarithmic return decreased by about 1.02, equivalent to a 64% decline in simple returns.
- Severe Impact of Tightening Monetary Policy Shocks:
- The model shows that monetary policy shocks contributed about 50 percentage points to the decline in Bitcoin's price. Without the impact of tightening monetary policy (such as interest rate hikes), the decline in Bitcoin's price could have been only 14%.
- Volatility Analysis:
- Most daily fluctuations in Bitcoin's returns cannot be explained by traditional risk premiums and monetary policy shocks; crypto demand shocks account for over 80% of daily volatility.
- The impact of monetary policy is mainly reflected in longer-term volatility, indicating that Bitcoin is a highly volatile asset whose volatility cannot be explained solely by traditional asset-driven factors.
This section emphasizes the influence of different factors on the volatility of Bitcoin returns, particularly the importance of monetary policy in the long term, while also pointing out the significant volatility of internal factors within the crypto sphere.
Therefore, the next part of the paper will explore the specific sources of crypto demand in more detail and how this variable affects Bitcoin's price.
Price Increase in 2021 Driven by Increased Crypto Adoption; Subsequently, Investors Gradually No Longer Demand High Returns from BTC
When analyzing crypto demand itself, the authors refine this influencing factor into:
The adoption of the crypto market itself (such as new technologies/narratives, market sentiment) and the risk premium of the crypto market (the additional returns investors require for taking on extra risk).
These two points also jointly influence the changes in Bitcoin's returns and the scale of the stablecoin market.
- Growth from 2020 to 2021:
The model indicates that the rise in Bitcoin's price from 2020 to mid-2021 was mainly due to the increased rate of crypto adoption. During this period, both Bitcoin and stablecoin prices experienced significant growth, reflecting a higher market acceptance of cryptocurrencies.
- Changes in 2022:
Since the end of 2022, the growth of stablecoins has slowed, and even declined at certain times. This led to a decomposition of Bitcoin's price showing negative crypto adoption shocks, indicating a decrease in interest and demand for Bitcoin, which also affected the demand for stablecoins.
- Since 2021, the continuous compression of the cryptocurrency risk premium has been a sustained driving factor for cryptocurrency returns.
In Figure a, the light blue line represents "crypto risk":
In mid-2021, this line dropped significantly, indicating a sudden increase in risk premium (investors became more concerned).
Starting from the end of 2021, this line began to rise slowly but steadily. This upward trend is referred to as "risk premium compression."
The rising line indicates that risk is decreasing, and investors no longer demand such high excess returns.
- Stablecoin Growth from 2020 to 2022:
During this period, the growth of stablecoins was mainly driven by the development of the cryptocurrency market. From the chart, we can see that the pink line (representing "Crypto Adoption") was relatively high before early 2022, indicating that the adoption of cryptocurrencies was the main factor driving the growth of stablecoins.
Starting in 2022, the chart shows that the blue line (representing "Conventional Risk") began to rise and surpassed other factors. This indicates that traditional financial market risk factors began to become the main driving force behind stablecoin inflows.
Traditional risk factors may include stock market volatility, economic uncertainty, inflation pressures, and other risks in traditional financial markets. When these risks increase, investors may seek stablecoins as a safe-haven asset.
Validation of Influencing Factors on Bitcoin Prices in Various Events
COVID-19:
Market Turmoil Background: During the period from January to May 2020, due to the impact of COVID-19, Bitcoin returns significantly declined in March 2020, while the stablecoin market size increased sharply. The market was described as being in a "risk-averse" phase, where the decline in asset prices exceeded what could be explained by changes in fundamentals.
Safe-Haven Role of Stablecoins: The growth of stablecoins during this period indicates that they acted as a safe haven in the cryptocurrency market, attracting inflows of investor funds. This validates the researchers' hypothesis that stablecoins can provide relatively safe investment options amid market uncertainty.
Risk Premium Shock: Investors' risk requirements for traditional assets (such as stocks, bonds, etc.) increased, leading to a decline in the prices of these assets. Similarly, investors' risk requirements for crypto assets (such as Bitcoin) also increased, causing its price to drop.
FTX Collapse:
Market Turmoil Background: In November 2022, during the FTX collapse, Bitcoin's price significantly dropped. The market size of stablecoins experienced a brief increase during the FTX collapse, indicating that stablecoins were still viewed as a safe haven amid market turmoil.
Market Reaction Differences: Under the direct impact of the FTX collapse, the crypto market experienced significant volatility, while the price changes in traditional markets were relatively small. This indicates that the crypto market reacted more sensitively to the FTX event.
During the FTX collapse, the shocks in the crypto market dominated, particularly positive risk premium shocks (increased investor requirements for crypto asset risks) and negative adoption shocks (decreased investor confidence in crypto assets). In contrast, the impact of shocks in traditional markets was smaller.
Launch of BlackRock ETF:
Market Warming Background: After BlackRock announced its application for a Bitcoin spot ETF, Bitcoin returns significantly increased. This event marked a major shift in investor sentiment and market dynamics.
Influencing Factors Analysis: The model identified two main influencing factors:
Positive crypto adoption shock: This reflects an increase in market acceptance and investor interest in Bitcoin, especially due to the legitimacy brought by the participation of large institutions like BlackRock.
Negative crypto risk premium shock: This indicates a decrease in investors' risk perception of Bitcoin, leading to a reduction in the excess returns required, meaning that the perceived risk of investing in Bitcoin has lessened.
Reasons for Bitcoin Price Increase: From September to December 2023, the rise in Bitcoin's price was primarily attributed to these declines in risk premiums.
From the above three examples, these findings emphasize the profound impact of significant market events (such as the involvement of large institutions) on the crypto market, particularly in terms of adoption dynamics and risk assessment.
This indicates that changes in market sentiment and the composition of participants can significantly influence the value of crypto assets and investor behavior.
