NFTs and Equities: Correlation or Coincidence?
Introducing 3Twelve Capital, a private crypto VC. We invest, advise and incubate web3 companies, with a focus on Defi, Gamefi and Infrastructure. We’re excited to kick start our research blog; covering broad macro trends between traditional markets and the world of crypto to deep dive analysis in DeFi arbitrage strategies, we aim to offer unique insights and thought provoking questions in the web3 revolution. Our first piece will be on NFT markets from a macro perspective: “NFTS and Equities: Correlation or Coincidence?”
What NFTs mean for asset diversification
Since the advent of Bitcoin and cryptocurrencies at large, it has become common for portfolio managers to draw parallels between Bitcoin and gold, or look for correlations between them and stocks. The lower the correlation is between them and traditional investment tools, the better its potential for diversification, and as an alternative investment. While this conversation is still evolving, the NFT market has joined the picture as a new asset class, and we try to understand whether they too, are correlated or not with the peaks and troughs of the stock market and should have a place in an investor’s portfolio.
For the original cryptocurrency, Bitcoin, there was a lack of correlation with the broader economy during its early days in 2009 to late 2010’s, however increased and growing awareness from retail and institutional investors since 2017 has created what appears to be a correlation between prices of the stock and cryptocurrency markets¹.
By 2022, not just Bitcoin and Ethereum, but the cryptocurrency market in general became more correlated with risk-on assets (i.e. tech stocks), Bitcoin reached a 0.95 correlation with Nasdaq in May this year¹. So for Bitcoin and general markets, the answer is yes in the current environment, it is correlated and behaves like a risk asset.
Just to keep Ethereum in the picture, we take a look at its correlation with Bitcoin, and can see that they have been highly correlated since late 2018, and the correlation has stayed above 0.9 since February 2022. An implication of this is that Bitcoin’s correlation with the Nasdaq consequentially holds true for Ethereum and the Nasdaq, during the periods where BTC-ETH have a high correlation.
What about NFTs?
Before answering that question, the first question we had to answer is, what dataset represents NFT market activity best?
Firstly, we used with data from secondary NFT sales i.e sales on Opensea, LooksRare, X2Y2 etc., instead of primary sales i.e. NFTs mintings. The reason was because anyone can create an NFT and mint it themselves, and there are likely thousands of NFTs that were minted e.g. on foundation.app but do not have any sales afterwards — so primary sales does not give a good picture of demand or trading activity.
Next, we had to decide which was the right proxy to use for trading activity: 1) sales volume, 2) unique buyer count, 3) number of transactions or 4) NFT Floor Prices.
Sales volume was ruled out first, as sales data is denominated in ETH or USD so fluctuations in the currencies themselves would skew the data and prevent us from seeing ‘pure’ trading activity, and also there would be greater weighting placed on ‘blue chip’ NFTs. Number of transactions seemed the better proxy in this aspect, as it avoids both these issues. While unique buyer count provides a more distilled version of this data by eliminating multiple transactions a day by the same buyer — a whale with the same wallet transacting 10 times a day would still only be recorded once a day under unique buyer count. In a strict sense it does not directly represent market volume, but for a new market like NFTs, we think this could be a fair proxy for market activity as it avoids over representing whale trading when the market size is not that large (2021 ~40bn³). NFT Floor Prices also suffers from being denominated in ETH/USD, and has a bigger issue of a selection process: which NFT floor prices to select? And what about projects that have low to zero volume? What denotes low volume anyway? While Floor Prices could be very interesting we think it is better explored another time.
We decided to focus on Number of Transactions and Unique Buyer Count, in fact we suspect they are quite closely related. A chart for Sales volume is in appendix A if there is interest.
So results:
Voila, Number of Transactions (light blue) and Unique Buyer Count (dark blue) do actually trend very similarly, when adjusted for scaling. They really are mutliples of each other, after all. From the two charts below, we can explain the trend using either one with the same implications, so we will equate transactions and buyer counts when referring to the charts below and simply call them NFT Activity. We have also charted these two against each other under Appendix B.
The first thing that is striking is that Nasdaq and NFT activity trended positively with each other from June 2021 onwards (between the two red lines). However, they only move in unison for a bit less than four months, until October. After peaking in November, Nasdaq remains rangebound while NFT activity continued to climb until March 2022.
So there is an apparent positive correlation starting early 2021, but less or none towards the end of the year. However because both NFT and equity markets enjoyed a sustained rally over 2021, they do end up showing a moderately positive relation in that year, this relationship breaks down after 2022.
The correlation coefficients calculated over these time periods confirm this:
On the left column Jan-Dec 2021 we can see that both Transactions and NFT Buyers had quite a moderate positive correlation with the Nasdaq, at respectively 0.61 and 0.64. However the right column shows that during the first 5 months of 2022, the correlation with Nasdaq not only breaks down, but goes the other way to a negative, consistent with the charts earlier showing NFT Activity and the Nasdaq going separate directions. So when combining the two timeframes and measuring over Jan 2021 to May 2022 (middle column), the correlation is almost zero, (0.08).
Conclusion
So the conclusion of the marquee question is NFTs hardly demonstrate correlation with equities over the past one year and a half,
making it a very viable candidate for portfolio diversification. That being said, there are questions that we think are worth asking or looking deeper into:
- The reason the 1.5 year correlation is so low is because 2021 and 2022 are showing near opposite correlations. Are the reasons pushing and pulling NFTs the same and if different, how much influence will they have in the future?
- E.g. Events like ETH 2.0 and Yuga’s Other Side were Crypto/NFT only catalysts while record inflation and rate hikes affect the broader economy including NFTs. But will the proportion of influence for each of these factors change in the future?
- Will the correlation with stock markets grow stronger as the entire NFT market develops, just as it did for Bitcoin?
- Is it possible that the correlation found in 2021 is coincidental, as NFT activity could be increasing due to growing interest in the industry, independent of broader market trends?
One thing is for sure though, the NFT market is growing rapidly and going through its own bull and bear cycles, but the number of participants remains on a firm uptrend.
Unlike the cryptocurrency market which has attracted institutional investments, NFTs are only beginning to see more large players entering and funds forming to take part in it. What we are seeing now may well be the tip of an iceberg of a nascent market.
TL:DR
- Bitcoin also showed no correlation to the broader market during 2009 when it first appeared. But it became more correlated as it grew and stabilised.
- Out of 1) sales volume, 2) unique buyer count, 3) number of transactions and 4) NFT Floor Prices, we find unique buyer count and number of transactions to be the most appropriate proxies for NFT activity.
- NFT market activity has had a moderately positive correlation to Equity market performance during the 2021 uptrend, but a negative one in the first 5 months of 2022. Over the 1.5 years up to May 2022 there is near zero correlation.
- More time and volume are needed for the NFT market to stabilize. But it is undeniable that NFT sales volume is increasing as there is more retail and institutional awareness.
About 3Twelve Capital
A private crypto VC fund specializing in incubating early stage web3 projects. Led by earliest employees at FTX, we have a collective experience in a series of investments and advisory covering DeFi, Infrastructure and GameFi projects including Solana, Magic Eden, Raydium, Star Atlas and more. Our team is dedicated to fostering the next generation of web3 entrepreneurs that we believe is the true driving force behind what defines the future of an open economy. We work alongside our portfolio to provide broad and pragmatic insights that strive for long term success every step of the way.
Bernard Yu — Researcher / Analyst (NFT) at 3Twelve Capital
Analyst with a background in analytics and business strategy. Follower of macro trends. Particularly curious about web3, NFTs and how they emerge, evolve and shape our web2 world.
[1] Is There a Cryptocurrency Price Correlation to the Stock Market?https://www.investopedia.com/news/are-bitcoin-price-and-equity-markets-returns-correlated/
[2] Kraken: Hold Steady. May 2022 Market Recap and Outlook https://kraken.docsend.com/view/scyxnqnb9tf8wqpf
[3]Chainalysis NFT Market Report https://markets.businessinsider.com/news/currencies/nft-market-41-billion-nearing-fine-art-market-size-2022-1
[4] Cryptoslam. NFT secondary data is across all available exchanges from the first available date. E.g. Dec 20th 2017 for OpenSea, Jan 10th 2020 for LooksRare and so on. Clarification on methodology was made in their discord server
Appendix A
Notes on the data selection:
- Only Nasdaq data was used for the comparisons for simplicity, instead of both S&P 500 and Nasdaq, as they show a close correlation of 0.9+ to interchangeably represent equity market movements.
- The data starts from January 1st, 2021, as NFT activity/volume prior to this was not significant enough to be meaningful for comparison.
Sales Volume Chart USD sales volume for NFTs vs Nasdaq and S&P is provided below for reference. Note the scaling used is different from the scaling in the previous charts.
Appendix B
Average transaction per buyer ranges from 1.3 to 3.6, with an average of 1.8.
