Crypto Market Cycles And Their Correlation With The Traditional Finance Industry

The cryptocurrency market is a fascinating place; it has seen many ups and downs, topline news, conflicts with regulators, and conventional centralized fanaticism during its history. This article will analyze its present state, compare cycles in the traditional financial industry and the crypto market, and discuss the collaboration between traditional financial markets and digital assets.

The current state of the cryptocurrency market

Despite the market slump and widespread negativity in the sector following the FTX crash, LUNA LUNA/USD collapse, and hacks we hear about each week, on-chain data shows reasons to remain positive about Bitcoin BTC/USD and other cryptocurrencies.

It's enough to look at long-term holders' positions, which have hit an all-time high despite their profitability being at an all-time low. Long-term investors invest extensively in the down market. They set the floor, and then long-term holders disperse their holdings to new market participants in the bull market.

Another encouraging trend to emerge from the FTX debacle is that ordinary crypto users are progressively moving away from exchanges and into self-custody of their currencies. This trend is proven by an outflow of cash from exchanges to self-custody wallets, as well as the increasing quantity of supply owned by entities holding between 0.1 and 1 BTC.

By combining those two metrics, you get this image of coins being transferred from exchanges into custodial wallets for the average retail customer. As a result, the market greatly benefits from this by bringing even more transparency to CEX business practices.

Cycles of the traditional financial industry and crypto market

Although the crypto market and the traditional financial industry are not one-to-one in essence, they are linked by a single concept: economic cycles.

Economic cycles are regular changes in business activity, ranging from boom to bust.  It is critical to recognize in what phase the economy is in at any given time. Another nuance is that these cycles vary in length and their impact on the economy and it’s hard to predict how long any of them will last.

Any economic event occurs at regular intervals, albeit at varying intensities. At the same time, the time elapsed between one peak of economic progress and the next is seldom consistent.

Let's compare the cycle phases of the crypto market and the traditional financial industry.

Crypto market cycles

Accumulation phase: The accumulation phase is the stage of consolidation that follows a prolonged price fall. During this stage, the price normally trades in a range.

Markup phase: When generally looking at the market, the run-up phase (also known as a bull market) is when the market begins to climb to greater highs at an increasing rate. This is the point when the market's trajectory becomes evident and the general attitude shifts from neutral to hopeful.

Distribution phase: Price plateaus and sellers take control in the third phase of the market cycle. The period during which the preceding phase's bullish attitude transforms into mixed feelings defines this phase of the cycle. As trading occurs in a confined range that might linger for days or weeks and price movement slows, the price appears to plateau.

Markdown phase: The recession is the market cycle's last stage (bear market). For the majority of investors, this is the most difficult and emotional moment, as they either do not see the permanency of market cycles or choose to ignore them, resulting in either selling too late or not selling at all.

Traditional financial industry

Rise phase: Stock markets are thriving as more investors flock to the market as rewards rise. The country's credit rating is strengthening, and fresh investments are flowing in.

Peak phase: This is the peak period for all macroeconomic agents' business activity. Production, investment, demand, employment, stock indices, and real estate prices have peaked, and growth has slowed.

Fall phase: Production volumes, business, and investment activities have been dropping for three or more months. Stock markets may continue to rise, but only if investors believe the issue will be resolved fast.

Depression phase: This is the bottom of the economic cycle. Production and employment are both minimal. Businesses are closing, investment is dwindling, and unemployment is at an all-time high.

As we can see, the phases of these sectors are quite similar since they are part of the same concept. Furthermore, if we look at the stock markets and cryptocurrencies, we may see a correlation in market values.

Cryptocurrency Price Correlation

Once bitcoin became an asset class, brokerage firms and various institutions received regulatory approval and investment opportunities. Investors seem to be more comfortable with cryptocurrencies as they now have familiar tools for using them.

As a result, cryptocurrency prices soared and dropped in the same way that stock prices did. During the end of 2021 and the beginning of 2022, the graph below compares the price of Bitcoin (BTC) to the S&P 500 (SPX) and Nasdaq 100 (NDX) to approve this statement.

It's worth noting that the graphs are placed on top of each other to compare results over time.

The SPX index measures the return on large-cap equities. The NDX index tracks the performance of the 100 largest non-financial businesses listed on the stock exchange, the majority of which are in the technology sector. From November 2021 to May 2022, the chart depicts the price history of SPX, NDX, and BTC. The values of each increase and fall in tandem, while bitcoin exhibits far greater volatility, implying that bitcoin is seen and treated like a stock. 

Bitcoin price appears to liaise with investors and traders who unwittingly construct a correlation, rather than Bitcoin being in any way tied to equities. They trade bitcoin the same way they trade the asset classes as their most familiar way.

Collaboration between traditional financial markets and cryptocurrencies

As previously mentioned, the crypto market is experiencing a market correction. Several coins have lost a large amount of their value, and major lending and investment organizations have gone bankrupt in crypto assets. However, it must be acknowledged that winter has arrived in the sphere of conventional finance, or TradFi, as members of the crypto-currency and decentralized finance (DeFi) community refer to the traditional financial and economic sector.

We are witnessing the biggest inflation in 40 years, a war that has shattered the international monetary system, an energy and commodities crisis that has resulted in hunger and political tensions, and record temperatures that have shown a significant lack of climate change investment. However, these two systems are mutually beneficial. To gain general acceptability, the DeFi and cryptosystems must adopt some of the same regulatory and self-regulation measures that have made the TradFi system functionally robust. At the same time, the chiefs of the international economy must immediately study solutions to tackle multiple economic difficulties using DeFi and cryptocurrencies.

The main goal is to discover the best combination and allow people to have the option to choose their path to financial freedom. The industry needs to make concerted efforts to build a healthy environment to promote the same and align on standard norms of self-regulation.

Regulators should impose greater fiduciary obligations on centralized financial services managers, classifying them as brokerage firms or other regulated financial institutions. However, in the case of DeFi operations, self-regulatory solutions must be developed in cooperation with industry participants, making use of technology benefits and depending on a decentralized structure. Most importantly, there must be an agreement on what defines a decentralized system and how justified the programmes purportedly moving in this direction are. In other words, all stakeholders from both the DeFi and TradFi worlds must first agree on principles and a common terminology before establishing standard norms. This is not a simple process, but it must be the critical first step in the right direction.