Bear markets have become almost routine for the price of Bitcoin and other cryptocurrencies. Since its launch in 2009, the price of Bitcoin has fallen by more than 50% on six occasions.
Coinbase CEO (COIN) Brian Armstrong, in a June 14 letter announcing an 18% employee cut, offered reassurance despite the recent bitcoin crash and the drop in other cryptocurrency prices. Armstrong said the cryptocurrency exchange has “survived four fantastic crypto winters” and is taking steps to do so again.
However, this storm is on a whole other level. “It’s a crypto ice age,” Mizuho analyst Dan Dolev told IBD. “I think it will be very deep and long lasting, and not many cryptocurrencies will survive.”
The explosion of the so-called “stable” TerraUSD, which wiped out $40 billion in market capitalization, has accelerated a wave of deleveraging that has yet to run its course. This month, crypto lending platform Celsius Network, which has overseen $20 billion in crypto deposits and loans, suspended withdrawals as it faced a liquidity crunch.
Terra, a blockchain payments and savings network, and Celsius have introduced double-digit interest payments based on bullish crypto scenarios. But the collapse of business models in the Old West is no more a cause than a symptom of the collapse of cryptocurrencies. The real reason the cryptocurrency market crashed: Bitcoin and nearly 19,000 other digital currencies are facing the first round of Federal Reserve tightening to stem rising inflation.
Cryptocurrency prices fueled by easy money
For most of its existence, cryptocurrencies have enjoyed the weakest monetary conditions. The period since Bitcoin was launched has mostly seen the Fed attempt to support demand. During this period, the Fed bought $6.5 trillion in government-backed Treasuries and mortgage-backed securities. These pent-up rates try to encourage risk-taking, increase asset values, and stimulate demand through wealth gains.
The bulk of the Fed’s purchases – $4.5 trillion – came after the coronavirus shutdown plowed a hole in the economy in March 2020. Combined with several rounds of fiscal stimulus, the Fed’s super-easy policy has been successful extremely good. All this monetary fuel has led to the economic reopening with a vaccine and led to the largest increase in inflation in 40 years.
Today, the Federal Reserve’s unprecedented stimulus reversal has deflated most asset values. The rise in the 10-year Treasury yield particularly affected growth stocks. Their future income streams are less valuable when discounted at a risk-free rate of return. This helps explain why the tech-heavy Nasdaq is underperforming in the broader market.
But when it comes to valuing bitcoin and other cryptocurrencies, there are no future cash flows to discount.
Bitcoin crash shows it’s not digital gold
The collapse of bitcoin has exposed the idea that it provides a hedge against inflation, like digital gold, Deutsche Bank economists Marion Labouri and Galina Pozdnyakova wrote in May. Instead of trading like gold, the rise and fall of cryptocurrency prices have been linked to the Nasdaq to an “astounding” degree, they wrote.
However, the movement of the cryptocurrency is making the volatility of the Nasdaq look boring. As of June 23, the Nasdaq is down nearly 31% from its intraday high on November 22. Bitcoin, which peaked on November 10, is down 70%.
Fed rate hikes and other tightening measures
Just days before Bitcoin’s decline began, the Federal Reserve announced that it would cut its monthly asset purchases by $120 billion. The timing doesn’t seem like a coincidence. In fact, the history of bitcoin’s peaks and valleys mostly coincides with changes in federal asset purchases.
Bitcoin’s first crash began in June 2011, just as the Federal Reserve ended its second round of asset purchases during a financial crisis. The second coincided with the crisis of the spring of 2013 regarding the possible erosion of a new round of asset purchases. The beginning of the actual devaluation at the end of 2013 coincided with the third crash of Bitcoin.
The crash at the end of 2017 coincided with the Fed’s rate hike that began when the Fed began to gently roll back asset purchases. However, none of these cases experienced anything like today’s crisis.
At the end of 2018, when monetary tightening helped create turmoil in financial markets, the Federal Reserve’s key interest rate was only 2.5%-2.75%. It was the highest in bitcoin history. However, once the S&P 500 approached the 20% bear market threshold, Fed policymakers signaled a change of course. In the fall of 2019, the Fed was cutting interest rates and buying more assets.
Read also Bitcoin (BTC) price is on the rise, and the $50,000 target appears to be within reach.
But last week, even though the S&P 500 and Nasdaq had already entered bearish territory, policymakers decided to accelerate their tightening plans.
The Fed does not target any specific asset class. However, a $2 trillion survey of cryptocurrency markets is in the pipeline.
“We have seen tightening financial conditions and rightly so,” Fed Chairman Jerome Powell said on June 15.
Bitcoin price crossed this line
In recent days, this bitcoin price drop has crossed a line that previous bear markets for cryptocurrency prices have not approached.
Bitcoin is down 75% from its November high of $68,990.90 to its June 18 low near $17,800. This briefly undermined its last major peak near $19,600 in December 2017. At its worst, bitcoin’s low in early 2015 was nearly 40% higher than the previous peak.
Bitcoin rebounded above $21,000 late last week, but drifted below $21,000. That’s just below the average purchase price of $21,000, says Mizuho’s Dolev.
Liquidating bitcoin’s gains over the past 4.5 years challenges the notion that long-term bitcoin holders cannot afford to lose. It will test this belief that ultimately determines the value of all cryptocurrencies.
This belief may have limits, but it is clearly deep. Nearly 50% of bitcoin traders on Coinbase say they will not sell no matter how low the price of the cryptocurrency drops, Dolev wrote on May 19. A Mizuho survey revealed that “the remaining ~50%, the tipping point is about $9,000.”
Despite the crypto price carnage, Silicon Valley venture capital firm Andreessen Horowitz announced a $4.5 billion crypto fund on May 25. In 2021, venture capital funding for blockchain companies reached $33 billion.
Cryptocurrency price leftovers
If you are wondering if cryptocurrencies are a good bet on recent crypto prices, keep in mind that the mania is just beginning to flare up. While Bitcoin peaked in November, the Luna cryptocurrency that was supposed to keep TerraUSD pegged to the dollar only peaked in April – before dropping to zero the following month.
The unraveling of excessive leverage, increased regulatory scrutiny, and a cycle of Federal Reserve tightening aimed at quelling speculative fervor point to a long crypto winter. Several business models that seemed viable and investments that made sense when cryptocurrencies did not suffer a long string of losses are facing their first major real-world test.
For some Bitcoin believers like the CEO of MicroStrategy (MSTR) Michael Saylor, who gambled $4 billion of the company’s money on cryptocurrency, the catastrophe is overdue.
“What you have is $400 billion in opaque, unrecorded, non-full and fair-disclosure securities transactions, all intertwined with Bitcoin,” Saylor said in an interview hosted by market analysis website Northman Trader.
The implication is that shady crypto practices and the successive margin calls that caused them are responsible for the recent Bitcoin crash. All of these other cryptocurrencies also undermine Saylor’s idea that bitcoin is a scarce resource. Bitcoin’s market capitalization is now around 45% of the total crypto value, up from 90% at the beginning of 2016.
What will happen after the ice age in cryptocurrency prices
The prospect of Saylor could undermine the Fed’s tightening role and the extent to which the need for collateral to fuel cryptocurrency speculation has helped boost the price of Bitcoin.
However, inflation will eventually subside and the Fed will end the tightening cycle. But the central bank is unlikely to return to ultra-accommodative monetary policy any time soon.
A new spring for cryptocurrency will finally arrive. Don’t expect it to look like its predecessors.