What is the connection between cryptocurrency and NFT?

Is there any connection between NFTs and the crypto market? Nathan Thompson, Chief Technical Writer at Bybit, examines some of the theories.

NFTs and cryptocurrencies have a strange relationship, similar to that of a parent and a child. When the NFT market was small, its price action was dependent on the crypto market, but as it continues to mature, they have been decoupling.

In January, when the cryptocurrency market was declining, NFTs were booming, with NFT trading platform OpenSea recording $5 billion in sales, a record high. Some cryptocurrency observers believe this means there is an inverse correlation between the crypto and NFT markets: when Bitcoin and other crypto markets rise, NFTs fall, and vice versa.

Others point to periods when the two markets have grown in sync, as was the case recently when the war in Ukraine began, when NFTs fell along with the rest of the market.

Found some correlations

There is little professional research on NFTs, but Michael Dowling, a professor at Dublin City University, released a study titled “Do Cryptocurrencies Drive NFT Prices?”

“Anyone active in the NFT market will be aware of the strong crossover between cryptocurrency market participants and NFT market participants,” the paper states.

This is partly because, to purchase an NFT, you need to use cryptocurrency as a means of payment.

However, cryptocurrency exchange Coinbase plans to make it easier to participate. Its much-anticipated NFT marketplace will allow users to purchase NFTs using their credit cards. In fact, companies like eBay, Reddit, and Instagram are all planning to integrate NFTs. But until then, the connection between the two markets will remain relevant, and besides, NFTs will always require blockchains like Ethereum and Solana to function.

“It is immediately apparent from the results that spillovers are much lower in NFT markets compared to cryptocurrencies,” Dowling’s paper reads. “Furthermore, even within NFT markets, spillovers are quite limited, suggesting that these markets are quite different from each other.”

A study by Blockchain Research Labs in June last year agreed with Dowling’s view. The study stated, “A decline in the value of cryptocurrencies means a decline in purchasing power, which may depress the NFT market. Conversely, when cryptocurrencies appreciate, investors tend to look for new or alternative investment opportunities.”

However, both papers were published in the first half of 2021. This year’s data suggests there may not be much correlation between the two.

An independent market?

A February report from Coin Metrics looked at the correlation between ETH prices and OpenSea sales to determine whether rising ETH prices led to a drop in NFT sales. The report said: "From the data, there does not seem to be a consistent correlation between OpenSea sales and ETH prices. It seems that NFTs are a relatively independent market that may be largely independent of the rest of the crypto market."

DappRadar also concluded that NFTs react differently to macro factors than the rest of the crypto market. “Despite negative macro indicators, it is undeniable that NFTs’ role in the metaverse and play-to-earn gaming has contributed to positive on-chain metrics,” DappRadar said in a January report.

However, some prominent traders still see a pattern between NFTs and the crypto market. They believe that when the price of Bitcoin and altcoins falls, money flows into NFTs. This may be because traders are looking for places to take profits or chase more gains, or because trading JPEGs is a fun pastime during times of market turmoil.

Using OpenSea daily sales data provided by Dune Analytics, we can identify two so-called “NFT bull runs.” The first began in late July last year, picked up in August, and then fell in September. The second major NFT uptrend began in mid-November and peaked on February 1 this year.

While NFT trading volume began to increase in July when BTC prices were low, both cryptocurrencies and NFTs saw growth in August. Bitcoin rose 76% that month before falling along with NFTs in September. Therefore, the only clear negative correlation was from November to February, when NFT trading volume surged while BTC and altcoins fell.

Chaotic situation

Interestingly, those most likely to argue for patterns and correlations are traders. Analysts and academics, on the other hand, are less confident in their conclusions. Lennart Ante, co-founder of Blockchain Research Lab, said: "I don't believe that the crypto markets will be so easily linked together. If Bitcoin falls 10%, no one wants NFTs; people would rather turn 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 market. But since the late 2021 boom, the NFT market has behaved differently.

Maybe this is just a bubble big enough to boost the NFT market even as other cryptocurrencies struggle. Or, we may be seeing a mature NFT market decouple from cryptocurrencies and go its own way. "The NFT boom in January was largely driven by social media hype and fear of missing out," Ante said. "There may be a long period of boom, and you never know how big this market can grow."

NFTs appear to be moving away from the cryptocurrency markets that spawned them, but they’re not entirely independent. They’re behaving like teenagers: rebellious, eager to forge their own path.

By Nathan Thompson