What Drives Crypto Asset Prices?

Abstract

We investigate the factors influencing cryptocurrency returns using a structural vector auto-regressive model. The model uses asset price co-movements to identify the impact of monetary policy and risk sentiment in conventional markets on crypto asset prices, with minimal reverse spillover. Specifically, we decompose daily Bitcoin returns into components reflecting conventional risk premia, monetary policy, and crypto-specific shocks. We further decompose the crypto-specific shocks into changes in crypto risk premia and levels of crypto adoption by exploiting the co-movement of Bitcoin with stablecoin market capitalization. Our analysis shows that crypto asset prices are significantly impacted by conventional risk and monetary policy factors. Notably, contractionary monetary policy accounted for over two-thirds of Bitcoin's sharp decline in 2022. In contrast, since 2023 the compression of crypto risk premia has been the predominant driver of crypto returns, independent of the buoyant equity market backdrop. Our findings highlight the importance of identifying drivers of crypto returns and understanding crypto's evolving relationship with traditional financial markets. 

Keywords: Cryptocurrency, Macro Finance, Bitcoin, Sign-restricted VAR