Crypto’s bear market is unlike others before it. This time the Fed’s steering the ship
September 20, 2022 Alex Rustok
Although it may not feel like it, the cryptocurrency industry has reason to celebrate. True, it’s been a bumpy ride this year — and for a good while, it seemed like a never-ending downhill trip. But Bitcoin is no stranger to plunges. The reason for jubilation is that while there has been lots and lots of pain, there haven’t been the same fears about bitcoin’s survival and what happens next. That’s thanks in part to recent wins that give the young asset class some legitimacy. It’s also because investors understand better why it moves and how it trades: the Fed is steering this ship now – and crypto traders, like stock traders, are waiting with bated breath for the central bank’s next signal later this week. Bitcoin’s correlation with stocks hit an all-time high in August, after failing (by many accounts) to realize its potential as the inflation hedge so many bitcoiners had espoused. “For whatever reason, whether we willed it to be so or it became technically so, crypto is trading like a risk equity asset,” said Sylvia Jablonski, CEO and chief investment officer at Defiance ETFs. “It was like ‘let the good times roll’ and then when those good times came to an end, crypto crashed like everything else,” she said. “It just tells me that it’s going to be the riskiest of risk assets, and it will behave and recover like equities will.” Several events brought us here. President Joe Biden ‘s executive order on crypto in March sent a message loud and clear to the crypto world and beyond that although the path to clear regulation has been foggy, the government is on its side. Then, last month bitcoin had fallen more than 70% from its all-time high in wake of Terra’s collapse. The financial contagion resulted in the loss of billions of dollars, after hackers stole $1.4 billion using crypto bridges. But the largest asset manager in the world gave many bitcoin believers the ultimate bullish signal by opening trading of the cryptocurrency to its institutional clients. In any other year, the bitcoin price would have skyrocketed after the BlackRock announcement, but it didn’t. Eyes and ears on the Fed With crypto shadowing stocks and inflation dominating all markets, the Federal Reserve has a much bigger influence on crypto than it ever has before. (Bitcoin is, after all, rooted in anti-establishment beliefs.) Investors say it pushed crypto into the well with its rate hiking plan, and that it’s on the central bank to pull it back out. “This is the first time we’ve seen quantitative tightening to the degree that we have since the invention of bitcoin,” said Valkyrie Investments chief investment officer Steve McClurg. “There’s definitely a drag on all markets due to the Fed continuing to take liquidity out of the system, and we don’t expect a true bottom to form until there’s a pivot either sideways or directionally the other way from the Fed.” Bitcoin hit its all-time high on Nov. 8, less than a week after the Fed first introduced the tapering . With almost every Federal Open Market Committee meeting this year, the Fed has gotten more aggressive, and bitcoin’s correlation with stocks has risen, while its price has fallen. Investors seemed to relax at the conclusion of the Fed’s July meeting, in which Chairman Jerome Powell hinted that the central bank could begin to slow hikes to assess their impact. However, his speech at the central bank’s Jackson Hole Economic Symposium the following month, where he warned that there was “some pain” ahead , rocked markets once more. Bitcoin hit what many believe to be its low of the cycle, $17,601.58, according to Coin Metrics, in June. Some technical analysts, however, see an opportunity for the cryptocurrency to turn lower – possibly as low as $12,500. Time, economic data and messaging after the Fed’s meeting Wednesday will tell. “The Fed will probably raise rates 75 basis points this week, while issuing forward guidance on raising rates at a smaller clip for November and December meetings, likely at 50 basis points each,” McClurg said. “This isn’t a change in direction from Fed tightening,” he continued. “…Until they change direction, by either pausing rate hikes or going the other way, we will be mostly risk-off as this spells lower prices in equities and crypto. Equities markets will likely move 20% down from here, with bitcoin likely retracing less.” Mistaken identity Bitcoin’s about-face is no mystery. In 2021, the cryptocurrency became institutionalized. After star investors like Stan Druckenmiller and Paul Tudor Jones named it as an emerging inflation hedge, other hedge funds jumped in and began trading it. Unlike early investors that would buy and hold on to it for dear life, or “HODL,” the new investors day-traded it, and as a result, they’ve been moving the bitcoin price more than the less active HODLers. “Bitcoin OGs want to believe that it’s a risk-off asset – that’s a long-term trajectory,” said Burak Tamac, senior researcher at CryptoQuant. “In the short term, it’s kind of confined to the rules traditional investors play by.” Bitcoin’s correlation with the S & P 500 rose to an all-time high this year. Some investors hoped to see the two decouple, particularly in February when Russia waged war on Ukraine and bitcoin briefly appeared to be a safe-haven asset in a time of great uncertainty. It hasn’t happened yet, though. It doesn’t mean bitcoin’s future is doomed, but at least in the short term, bitcoin has really just become a 24/7 VIX — an extension of the Nasdaq.” Chief investment officer, Arca Jeff Dorman It’s not the first time the identity of bitcoin has morphed. Some investors continue to keep their distance from it for that very reason, unsure about how to value the asset. And it’s unlikely it will be the last. For many, the beauty of bitcoin lies in its ability to satisfy any thesis , be it a risk asset, digital gold, an alternative system or a revolutionary technology. “I look at bitcoin as an independent investable asset class,” Jablonski said. “I would not invest in it because I believe it could be an inflation hedge, I’ll invest in it because there’s innovation there, practical use cases, there’s been growth, commercial adoption, a massive increase of both retail and institutional users. That makes it interesting and gives it potential to grow in price appreciation.” For others, however, bitcoin has become just more boring than that. Arca chief investment officer Jeff Dorman said bitcoin has become a macro asset in large part because the cryptocurrency has lost its narrative. “It hasn’t proven to be defensive. … It’s not proving to be an inflation hedge. It certainly isn’t being used as a medium of exchange – dollar stablecoins have taken over for that,” he told CNBC’s “Crypto World.” “It doesn’t mean bitcoin’s future is doomed,” Dorman said, “but at least in the short term, bitcoin has really just become a 24/7 VIX — an extension of the Nasdaq. It’s trading in lockstep with equities and the macro environment, whereas other digital assets are starting to move more idiosyncratically.” Down bad, but still buying Bitcoin’s 70% drop is not the largest peak-to-trough decline the cryptocurrency has seen, but it is the first time many new investors who entered the market in the past couple of years have experienced such a steep slide. Data shows there’s confidence in the market, however. According to CryptoQuant, investors that entered the market in the past six to 18 months are still consistently accumulating bitcoin; meaning they bought it, are holding it and are buying more. “People aren’t that scared this time,” he said, attributing the sentiment to their taste of the first bull run after a crash. Bitcoin rose to a high of about $64,000 in April, and after a summer slump, hit its all-time high of $69,000 in November. “In previous cycles, when we saw the all-time highs followed by the bear market, it would take years to see the next all-time high. When the bitcoin price dropped dramatically in May 2021, people expected there to be a bear market for a long time, but it only took until November to recover and see the next all-time high.” However, Tamac said the runup to it was different from those before it. The period of accumulating and selling over the past year and a half is distorted, he said. Long-term holders (those holding for 155 days or more) typically sell their bitcoin to short-term holders (55 days or less) at the market top, and begin accumulating at the bottom. However, after bitcoin hit its April high, it didn’t see that typical period of high distribution, Tamac said. Instead of selling, investors in May accumulated, and continue to today. “That’s a good thing because the newbies got this four-year experience in one year, so to speak,” he added. Lessons from crypto contagion Besides the fact that investors continue to hold and buy more even in the face of this year’s downturn, some long-term good came of all the destruction. Aside from macro drivers, crypto has the added handicap of the stain left by the financial contagion stemming from the collapse of Terra in the first half of the year. That triggered a sell-off that ultimately contributed to the fall of Three Arrows Capital and crypto lenders Celsius and Voyager, and billions in investor losses. It also bruised an industry that’s been so zealous in its attempts to adjust the balance of power between “the big guy” and “the little guy.” “If you can’t access your money, whether it’s in crypto or anything else – we’ve probably lost some investors in crypto because of those types of events that happened,” Jablonski said. However, she added, “I think that’ll pass and that the bigger picture of the opportunity in crypto remains uncontested.” If anything, that catastrophe demonstrated more about the flaws in the traditional banking system that bitcoiners have sought to reinvent, according to Felix Hartmann, managing partner of Hartmann Capital. That’s because private, centralized companies that took the spotlight like Celsius and Three Arrows Capital were able to remain tight-lipped about how much leverage they had. Meanwhile, many have been quick to point out that decentralized finance platforms like Compound and Aave — which use self-executing smart contracts to make sure lenders are paid back in situations of market turmoil — continue to function as designed. “People gave money to Celsius, people gave money to BlockFi,” he said, calling them “wolves in sheeps’ clothing.” “That’s a lot more like what happens with banks than with crypto, because ultimately you give it to an opaque institution, and they do with it what they want. They trade it, they invest it, they make deals with it.” “With DeFi, everything is fully transparent on-chain, so you can see what happens with your money, and that the yields go straight to you, versus becoming cuts taken by banks or companies like Celsius,” Hartmann said. In the future, “people will trust platforms like Aave and Compound and MakerDAO more than they trust the next Celsius because they will ask, ‘what are you doing with our money?’ And the best way to transparently show it is on-chain, which is what this industry is here for,” he said. Currently, Ethereum and Solana are the most popular blockchains for developers working on decentralized finance apps, but there are several developers working to build DeFi, NFTs, and other apps and smart contracts on top of Bitcoin. They argue that bitcoin can be a more productive asset than something you buy and hold while watching the price move. ‘Institutional adoption’ as a catalyst Two years ago, MicroStrategy did an unthinkable thing: it adopted bitcoin as its primary treasury reserve asset, acquiring 21,454 bitcoins at an aggregate purchase price of $250 million or roughly $11,653 per bitcoin. That alone was a bigger catalyst for the bull run of a few months later than most people remember. It wasn’t just the hedge funds that drove bitcoin’s price surges last year; investors rallied around the idea that more companies could start to do the same, and push the price of bitcoin to new highs. Tesla and Square (now known as Block ) followed in putting bitcoin on their balance sheets in February 2021, helping fuel bitcoin’s first price run-up that year. Cathie Wood’s Ark Invest estimated that if 1% of the corporate cash of every company in the S & P 500 were converted into bitcoin, the bitcoin price would balloon by more than $40,000 ; if each company converted 10%, then $400,000 was a reasonable outlook for bitcoin. “Institutions trading bitcoin and institutions holding bitcoin are two different things,” Tamac said. “When they put bitcoin on their balance sheet, that takes those bitcoins from the market and they hold it, and they don’t sell it. They actually drain the supply. Their intention is not to make a profit in six months or one year.” The hype eventually faded away, largely because of regulatory uncertainty at the time. “Institutions hesitate to take initiative as much as they would if the government provided clear, understandable and easy-to-follow regulations,” Tamac said. “ESG is one of them because there is still uncertainty about the government’s stance on bitcoin mining and the energy use.” Anxiety about the negative environmental impact of crypto seems to be taking a turn now, thanks largely to Ethereum’s transition from proof-of-work to proof-of-stake last week, also known as the merge, which cut the network’s energy consumption by more than 99% . It’s bitcoin that’s received so much hostility about being environmentally unfriendly, but myths about the cryptocurrency’s environmental impact are slowly being debunked . When BlackRock announced its bitcoin trust last month, it said it’s “encouraged” by energy nonprofits committed to transparency around “sustainable energy usage in bitcoin mining.” That could encourage other institutions to rethink their stance. The next bull run If there’s a day when institutions begin holding bitcoin, it seems far away for now, especially after Tesla sold 75% of its bitcoin holdings over the summer. It’s one of three scenarios that could initiate the next really big bull run, along with the approval of a spot bitcoin ETF and more countries adopting bitcoin like El Salvador did last year, according to Tamac. Callie Cox, an analyst at retail brokerage eToro, said the time horizon for companies making bitcoin part of their corporate treasury strategy is a long way off, but she’s confident the upswing will mirror that of NFTs last year – though maybe not as suddenly. At this point in time, crypto might be in a better place relative to other markets because of how far it fell amid the financial contagion in the first half of the year, Valkyrie’s McClurg said. Still, he sees recent upward moves as “macro market bull traps” and said he expects all markets to go down another leg from here. Though bitcoin topped $25,000 last month following its June lows, chart analysts still expect to see it sink again , maybe as low as $12,500 this year. Beyond bitcoin, crypto remains just a little too out of reach for many. That’s true for even some of the biggest successes like decentralized exchanges and NFT platforms like OpenSea, according to Hartmann. It’s been more than a decade, but crypto “hasn’t really hit the mainstream outside of the speculation aspect,” he said. “Crypto as an asset needs to really find a new narrative for itself because the reality is that over the next two to three years prices will be highly correlated to tech stocks,” Cox said. “There’s a lot of innovation happening,” she added. “These explosions in lending platforms have not been a step forward for the industry, … but people have never seemed more optimistic, committed or certain of crypto’s survival. When prices drop and it’s not all about financial speculation, then we have the space to discuss the transformative non-financial use cases of blockchain.”
