If the last 12 months in cryptocurrency has taught us anything, it's that people really like owning a piece of code that proves they overpaid for a JPEG file. And it's not just about monkey pictures either. Soon NFTs (non-fungible tokens) will be used to trade music rights, real estate and debt instruments.
NFTs have a strange relationship with cryptocurrencies. It’s similar to that of a parent and child. When the NFT market was small, it depended on the crypto markets for its price action, but as they have matured, they have been breaking away.
When the cryptocurrency market did its best impression of a downhill ski slope in January, NFTs were booming, with NFT trading platform OpenSea recording $5 billion in sales volume, an all-time high. Some crypto observers thought that meant there was a reverse correlation between crypto and NFT markets: When bitcoin and the rest of the crypto market goes up, NFTs go down, and vice versa.
Others have pointed out times when both markets have moved in sync as was the case recently when NFTs sank along with the rest of the market when the war in Ukraine began.
Some correlation found
Professional research on NFTs is thin, because just a couple of years ago, most of the market didn’t exist. One study that looked into the subject is titled “Is Non-Fungible Token Pricing Driven by Cryptocurrencies?” by Dublin City University professor Michael Dowling.
“Anyone active in the NFT market will be aware of the strong crossover between cryptocurrency market participants and NFT market participants,” the paper states.
That is partly because to buy an NFT you need to use cryptocurrencies as a means of payment, a nontrivial level of complexity for many people.
Crypto exchange Coinbase, however, plans to make participation easier. Its much anticipated NFT marketplace will allow users to buy NFTs with fiat using their credit cards. Indeed, companies like eBay, Reddit and Instagram all have plans to integrate NFTs, also likely using fiat options that may cause NFTs to further decouple from crypto. But until that happens, the connection between the two markets remains pertinent, and besides, NFTs will always need a blockchain like Ethereum and Solana to function.
“Immediately apparent from the results is that, compared to cryptocurrencies, there is much lower spillover from and to NFT markets,” Dowling's paper says. “Further, even among the NFT markets there is quite limited spillover, suggesting these markets are quite distinct from each other.”
A study last June by Blockchain Research Lab agrees with Dowling. “A drop in cryptocurrency value means lower purchasing power, which is likely to depress the NFT market,” the study says. “Conversely, when cryptocurrencies appreciate, investors tend to look for new or alternative investment opportunities. This is especially plausible in the context of ETH, the standard denomination of NFTs.”
Both papers, however, were released in the first half of 2021 before the NFT market took off. Data from this year suggests that there might not be much correlation between the two after all.
An independent market?
A Coin Metrics report from February looked at the correlation between the price of Ether (ETH) and the sales volume of OpenSea to see if rising ETH price caused a drop in NFT sales. “Looking at the data there does not appear to be a consistent correlation between OpenSea sales volume and ETH price,” the report says. “It appears that NFTs are a relatively independent market and may, for the most part, move separately from the rest of the crypto market.”
DappRadar also concluded that NFTs respond differently to macro factors than the rest of the crypto markets. “The undeniable role that NFTs play in both the metaverse and the play-to-earn narratives has primarily contributed to positive on-chain metrics despite unfavorable macro indicators,” a DappRadar report from January says.
Some prominent traders, however, still see patterns between NFTs and crypto markets. They argue that when the prices of bitcoin and altcoins decline, money moves into NFTs. That could be because traders are looking for somewhere to take profits or to chase more gains or because trading JPEGs is a fun diversion during times of market turmoil.
Using data on OpenSea’s daily sales volume from Dune Analytics, we can identify two so-called “NFT bull runs.” The first started in late July and picked up steam in August before declining in September. A second major NFT uptrend began in mid-November and peaked on Feb. 1.
While NFT volume started to increase in July when BTC's price was in the doldrums, both crypto and NFTs posted gains In August. bitcoin gained 76% that month before declining in September along with NFTs. So the only clear case of inverse correlation has been November-February when NFT volume boomed while BTC and altcoins declined.
A muddled situation
It’s interesting that those most likely to argue for patterns and correlations are traders whose job it is to see patterns and act with conviction. On the other hand, analysts and academics are less cocksure in their conclusions. “I don’t believe crypto markets are so easily related,” said Lennart Ante, co-founder of Blockchain Research Lab. “If bitcoin drops 10%, no one wants NFTs; people would rather move to stablecoins.”
What’s clearer is that when NFTs were in their infancy – before March 2021 – there was a spillover effect from the larger cryptocurrency markets. But since the late 2021 boom, the NFT market has behaved differently.
Maybe it’s just a bubble that has been big enough to elevate the NFT market even as the rest of crypto is floundering. Or maybe we are seeing a maturing NFT market decouple from crypto and go its own way. “The January NFT boom was mostly driven by social media hype and fear of missing out,” Ante said. “The boom could still have a way to go and you never know how big something can get.”
NFTs seem to be moving away from the cryptocurrency markets that birthed them but are also not fully independent. They are behaving like teenagers: experimental, rebellious and keen to go in their own direction.