Last week, Bitcoin dominance reached the highest level since October 2021. It looks like in the aftermath of the TerraUSD collapse, crypto investors reduced risk and preferred to own the most recognized digital asset. It is like a flight to safety in the stock market when traders expect an economic downturn and buy low-volatility, high-quality companies like Johnson & Johnson or Procter & Gamble and sell high-risk names like Tesla and classic high beta like Boeing.
When Bitcoin dominance was at the same level in October 2021, that nearly coincided with peak price and a downtrend ahead. Bloomberg discussed the topic in an article titled “Bitcoin's Crypto Dominance Is Strongest Since Bull Market Highs”. Well, considering the current level of Bitcoin dominance as high or low is very much a matter of perspective. Just compare 1-year and 5-year charts below!
Bitcoin dominance (% of crypto total market cap), 1 year
Bitcoin dominance (% of crypto total market cap), 5 years
The shift of Bitcoin dominance ranges from 60-70% in 2020 to 40-50% in 2021-22, which is mainly explained by the rise of stablecoins and DeFi in the first half of 2021.
Market cap of Bitcoin, USDT, and DeFi in 1H 2021 (indexed at 100% as of 12/31/20)
DeFi's market cap was very volatile and dropped by more than 2 times in 2022, but stablecoins gradually increased their market caps. Now 3 largest stablecoins (USDT/Tether, USDC/USD Coin, and USDB/Binance USD) account for 12% of the total crypto market cap (according to our calculation based on TradingView data).
Market cap of USDT, USDC, USDB, and DeFi (USD billions)
So recent increase of Bitcoin dominance to the highest level since October 2021 is largely driven by the DeFi plunge. DeFi was also a major factor behind the Bitcoin dominance drop in the first half of 2021. But is it a coincidence that Bitcoin reached a historical maximum a few months after the DeFi rally? Should we consider the recent DeFi plunge a warning sign for Bitcoin?
The relatively short history of crypto leaves little historical data to answer these questions. However, we can find an analogy in the stock market, which has a long and well-studied history. We can compare Bitcoin to the largest stock or group of the largest stocks, DeFi to small-cap stocks, and Bitcoin dominance to stock market breadth.
Small caps often lead the stock market to the beginning of a new trend. For example, the economy reopening rally after the first coronavirus vaccines started with massive out-performance of small caps (Russell 2000) vs. a broad market (S&P 500). As the rally matured, small caps stalled, but the broad market continued to increase.
Russell 2000 and S&P 500 in October 2020-December 2021 (indexed at 100% as of 10/01/20)
On the contrary, late-stage market gains were driven by stocks with very large caps (like Apple).
Apple and S&P 500 in October 2021-February 2022 (indexed at 100% as of 10/01/21)
During the subsequent downtrend, small-cap stocks started to falter a few months earlier than the broad market.
Russell 2000 and S&P 500 in November 2021-June 2022 (indexed at 100% as of 11/01/21)
So, suppose we apply the market breadth concept to crypto. In that case, we will find it very expected that after the DeFi rally in the first half of 2021, Bitcoin recovered from the 35% correction of May 2021 and later established a new high (in November 2021). The recent drop of DeFi and the accompanying rise of Bitcoin dominance appear concerning, but the degree of this concern is difficult to gauge. The current level of Bitcoin dominance does not appear very high in the longer-term context or compared with the overall crypto market cap drop. Still, the combination of decreasing Bitcoin price and increasing Bitcoin dominance suggests that a downtrend continuation is more likely. We think there is no major bear point, but there is no reason to turn bullish yet.
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