Fundamental analysis of financial assets can be performed using two approaches:
- Micro analysis
- Macro analysis
While micro analysis deals with the assessment of financial assets using micro-economic indicators, macro analysis uses the macro-economic indicators to provide direction on the future price movements of financial assets. Macroeconomic indicators refer to factors that tend to affect an economy as a whole, and these usually emanate at the centre; usually at the level of government and its agencies.
This piece deals with which of these macroeconomic factors play an important role in the analysis of crypto currencies, and how they can be used to determine price action.
What Drives Crypto Prices?
Crypto currencies were not originally designed as financial assets, but rather as disruptive blockchain-based technologies that could drive industry-wide innovations. With crypto currencies are today being traded on exchanges all over the world, it has become difficult to establish a pattern of fundamental influences that are responsible for the supercharged price activity that has been seen in crypto currencies since the start of 2017. This has put some pressure on market analysts to attempt to define those internal and external influences that cause prices of Bitcoin and other altcoins to increase or decrease.
Fundamentally speaking, price is a consequence of the balance between demand and supply. When demand is greater than supply, prices go up. When supply outstrips demand, prices fall. But what macroeconomic factors drive demand and supply of crypto currencies, causing such massive price shifts on a daily basis? This is what macro analysis of crypto currencies aims to discover.
Common Macroeconomic Factors Used in Crypto Analysis
Crypto currencies are here to challenge the control that central authorities have over the control and supply of money. Central governments, through their monetary agencies, control how fiat money is created and supplied. Central governments also dictate the rules on how financial assets are traded within an economy. So they control how money is created, how it is supplied, and using the interest rates, also dictate the cost of accessing, borrowing and using such money. It therefore makes a lot of sense that you will see fundamental factors at the central level playing a huge role in the prices of crypto currencies. This makes it easy to apply macro analysis to cryptocurrency trading.
The following fundamentals can be used to analyze cryptos at the macro level.
Government regulation has shown to have the greatest impact on prices of Bitcoin and other crypto currencies. The very fabric of crypto currency creation was to eliminate the control or fiat the government has over the creation and ownership of money. Therefore, we see government regulation and demand for crypto currencies as two opposing factors with an inverse relationship. As governments have exerted some form of control over the mining and distribution of crypto currencies, prices of Bitcoin and other crypto coins have shown a correlation with such actions. There are two clear instances of this scenario playing out in the Bitcoin market.
The first example cited here occurred in September 2017, when the Chinese government banned the issuance of Initial Coin Offerings and shuttered all crypto currency exchanges in the country. Prices of Bitcoin lost nearly half of its value as a result.
In January 2018, South Korea’s justice ministry put out a statement that it was considering banning cryptocurrency trading. With a large number of cryptocurrency traders located in that country, the impact of the announcement was huge. A massive selloff ensued, sending Bitcoin plunging from its record highs of December 2017 all the way down to less than $6000.
These two instances show clearly that government regulation has a heavy impact on the demand and supply of crypto currencies. Government regulation tends to come at different levels:
- Restrictions on transfer of fiat money to crypto exchanges for the purpose of funding trading accounts.
- Restrictions on operations of exchanges.
- Bank prohibitions on the use of credit/debit cards by bank customers to pay for crypto purchases.
- Restrictions on anonymous account operations.
Centralized control of crypto currencies is also likely going to start occurring at the level of financial market regulators.
Oversight by bodies such as the Securities and Exchange Commission is now a topical issue. Major regulatory agencies that oversee the financial markets are all agencies of governments. One major concern of governments with respect to the use of crypto currencies is that the anonymous nature of transactions can easily be exploited by entities involved in terrorism, illicit financial activity and organized crime to bypass existing controls which have made it difficult for these dark organizations to access the financing for their operations. Already, there are accusations from the South Korean spy agency that the cash-strapped North Korean regime is behind the hacking of some exchanges located in South Korea to acquire funds in order to bypass international trade sanctions. There is now a push by central regulators in several countries to bring crypto currencies under their oversight to unmask crypto users and block illicit financial flows.
If their aim is achieved, this will negate a fundamental principle behind the creation of crypto currencies. However, it is yet unclear how the market will perceive such oversight, as no major regulator has been able to achieve this aim so far.
Crypto currencies can only be obtained either by mining or by buying them from an online exchange. They can also be obtained from informal person-to-person exchange or as payments for services rendered/goods sold. Majority of people who possess Bitcoin or other altcoins would have procured them from an exchange. Some exchanges provide wallets where their clients can store their coins, especially if those clients are active traders. Crypto trading on an exchange can be lucrative, but there is a huge challenge. On-exchange wallets can be hacked and funds running into millions can be stolen.
Major exchange hacks have happened to the following exchanges:
- Gox (2014), leading to loss of 650,000 Bitcoins worth $473 million at the time, and $5.2 billion as at December 2017.
- Enigma ICO (2017), leading to theft of 1,500 Ether (about $500,000)
- Tether, leading to loss of $31 million worth of USDT tokens.
- Verisateum (2017): lost $8 million worth of Ether
- Bitfinex (2015 and 2016): This exchange was hacked twice, losing 119, 756 Bitcoins in the second attack.
More than 30 high-profile exchange hacks have occurred in the last 5 years. Some exchanges have recovered, but many cannot and they fold up. Anytime an exchange is hacked and crypto coins are stolen, it produces intense fear and panic among those who have coins in other exchanges. Such panicked traders start to sell off their holdings, leading to a glut and consequent price decline in the affected crypto currency. The crypto market has been one where a rising or falling tide tends to raise or sink all boats, so once a major crypto like Bitcoin starts to take a hit, other altcoins tend to follow.
Unfortunately, just as offline theft and robberies have been around for centuries, online theft of crypto in the form of exchange hacks are not going to go away. As long as not all users of crypto exchanges are tech savvy enough to recognize phished sites from the real ones, and as long as some exchanges do not use high-grade cyber security protocols, there will be vulnerabilities in the system which will be exploited by hackers.
The revelation of the involvement of rogue regimes in exchange hacks has taken the problem to a whole new level. Dealing with individual hackers is bad enough; how do you deal with an entire government with resources at its disposal to carry out hacks of enormous magnitudes?
News, whether real or fake, has an impact on market sentiment and dictates trader behavior in the market. Last week, a rumour hit the market on possible integration of Ripple by Coinbase, a US-based exchange that accepts fiat currency in exchange for cryptos. This caused the price of Ripple to rise by 18% on March 4, 2018. However, Coinbase later debunked the rumours and this caused traders to dump Ripple, causing the price to tank badly.
Markets thrive on rumours, hearsay and actual news. These tend to cause prices to swing wildly in both directions.
Sales of Confiscated Coins
Law enforcement agencies across the world have confiscated large amounts of crypto currency from individuals and companies believed to be involved in organized crime. These coins are now being released into the market following the conclusion of court processes authorizing the sale of these confiscated coins. As they get dumped into the market in large numbers, it is very likely that these will impact prices. For instance, the US Marshalls Service is planning to auction 2,170 Bitcoins seized in the course of its work on March 19, 2018, with bidders to place a $200,000 minimum deposit in order to participate. What will be the impact on prices on that day?
We can look to what happened with Bitcoin prices between December 22 and February 5, with Bitcoin prices taking a hit following the sale of more than $400 million worth of Bitcoin and Bitcoin Cash by the trustee of Mt.Gox, Tokyo attorney Nobuaki Kobayashi. These coins were sold in four batches, each time crashing Bitcoin prices.
1st sale by Mt.Gox trustee Kobayashi in November 2017
Another round of sales from the remaining stash of Bitcoin still housed by the defunct exchange will be conducted in September 2018, as the trustee continues to pay off creditors and former clients of Mt.Gox.
These large scale dumps of crypto into the market by central governments and trustees of defunct exchanges are events that macro analysis of the crypto market should watch out for.
Can Google Trends Be Used to Predict Bitcoin Prices?
On a final note, attention will be drawn to an interesting correlation that has developed between the global search volume on Google Trends for the word “Bitcoin”, and the price movement for the BTC/USD asset.
So the question that has developed is this: can Google Trends be used as a predictive tool to gauge Bitcoin prices? Yes, according to SEMRush, a company which has been in the search engine marketing ecosystem for several years now.
SEMRUsh conducted a study in 2017 in which 120 million keyword searches that were tied to the word “Bitcoin” were assessed. The results showed that Bitcoin prices had a 91% correlation to the volume of search requests that had words or phrases featuring “Bitcoin”. The two charts are shown below, and one can easily see the almost similar movement in the two line charts.
© 2018 Google Trends snapshot showing global search volume for the word “Bitcoin”
While not making an attempt to wholeheartedly sanction the use of Google Trends as a Bitcoin trading tool, it can be seen that interest in the cryptocurrency (as depicted by rising volume of Bitcoin-related searches) correlates with people moving to exchanges to put a demand on Bitcoin, and lessening public interest leads to reduced demand for crypto currencies on exchanges, thus producing the nearly similar correlation.
Crypto currencies are highly amenable to macro analysis, and as we head deeper into 2018, it is very likely that macroeconomic impact on crypto currencies will become more mainstream, tasking the abilities of traders to respond appropriately in their trade endeavors.