The dramatic events of 2022 will shape the crypto landscape for years to come.
Yet, despite the uncertainty surrounding the potential fallout, there are important characteristics that distinguish this market from the previous crypto winter. For one, institutional crypto adoption remains firmly entrenched. Many investors take a long-term perspective and recognize the cyclical nature of these markets. Rather than stepping back, they are using this environment to hone their knowledge and build the infrastructure to prepare for the future.
But no one is arguing that digital assets haven't faced an important setback. The total market capitalization of cryptocurrencies is currently around US$835 billion, down 62% from $2.2 trillion at the end of 2021, albeit still high relative to most of the asset class’ history. Comparatively, the Nasdaq is down 30% since the end of 2021 and the S&P 500 down 18%.
From a Sharpe ratio perspective however, crypto's risk-adjusted return actually performed in fine with US and global stock indices through 2022 and did much better than US bonds. Prior to the fallout in November, an equally-weighted basket of BTC and ETH offered a negative Sharpe ratio of 1.08 compared to an average negative return of 0.90 for US stocks. This is a significant deviation from the trend observed in the last crypto winter, when digital assets underperformed nearly alL traditional risk assets for the duration of 2019 and into early 2020.
Chart 1. Rolling 1y Sharpe ratio
Sources: IEX Cloud and Coinbase.
The differences between these periods may also be observed in the prospective fallout from the latest crypto downturn. For instance, we expect greater calfs for regulatory clarity to emerge, as institutional investors push for better governance and standards to help make the asset class more accessible, safer, and easier for all to navigate. This will take time, however, as the industry puts Lessons about systemic deficiencies in the right context and applies the necessary risk controls to protect its customers.
Looking ahead, we believe the evolution of the crypto ecosystem is putting subjects like tokenization, permissioned DeFi, and web3 front and center. Meanwhile, bitcoin's core investment thesis remains intact, whiLe Ethereum seems to be outpacing its layer-1 competition in terms of network activity.
We are seeing a greater variety of use cases for non-fungible tokens outside of art, like using NFTs to certify and authenticate real-world assets or as ENS domain names. Stablecoins are now one of the largest sectors in the crypto ecosystem with an outsized role in storing and transferring wealth.
We discuss these trends and many more in the enclosed report, starting with the key themes we expect in 2023. If you have questions about our work or want to understand how Coinbase's institutional practice can help your firm engage with the crypto markets, please contact us at institutional.coinbase.com.
David Duong, CFA
Head of Institutional Research
Brian Cubellis, Research Analyst
Li Liu, Senior Quantitative Researcher Viktor Bunin, Senior Protocol Specialist Aiden Mathieu, Senior Content Strategist Mark Meadows, Product Marketing Manager