The government stimulus of trillions of dollars and rock-bottom rates helped to boost the prices of digital assets. They are essential for the market’s stability.
True believers in cryptocurrency believe that Bitcoin is the best store of value and the best hedge against inflation created by reckless central banks. The Crypto world as a whole is a fraud. The $2 trillion run-ups were simply speculative. It’s a result of an extraordinary amount of cash floating around in the global economy.
Both theories will be put to the ultimate test.
Bitcoin, the first cryptocurrency, was created more than a decade ago from the ashes and chaos of the global financial crisis. It is a way to bypass Wall Street’s terrible financial crisis. The popularity of the digital token grew steadily, sparked a lot of people who wanted to be cryptocurrency miners and gave rise to some crazy adventures. The market took off only after the next major crisis, Covid-19.
After March 2020, the Federal Reserve and Congress released trillions of dollars of stimulus money to curb the economic impact of the pandemic. Crypto boomed. A lot of this cash ended up in digital assets, which boosted prices. Bitcoin rose by 305% in 2020 and then soared another 60% in the next year. It reached a new high of nearly $69,000 in November. It has been on a steady slide since then, due to the central bank’s hawkish pivot. With the possibility that policymakers will begin a series of rate hikes in March, which is just one of many steps they are set to take to remove liquidity — it’s unclear if the crypto ecosystem can withstand it.
It doesn’t look good. Bitcoin is down 40% since its peak, while Ether, the 2nd coin, and other “altcoins”, have also seen steep declines.
“If they are going to raise rates three times in 2022, and keep the program,” Stephane Ouellette, chief executive of crypto platform FRNT Financial Inc., said that “if they’re going hiking rates three times in 2020 and keep the program,” it would be a bad sign for valuations.
Michael O’Rourke is JonesTrading’s chief market strategist. He said that “The Federal Reserve’s seemingly permanent asset purchases have been the cornerstone of crypto investing.” O’Rourke stated that if the central bank follows the latest minutes release path, which indicated that Fed officials are willing to move faster than anticipated to raise interest rates and shrink the bank’s bank’s balance sheets, then it would “immediately undermine the key bullish thesis of Bitcoin and many other cryptocurrency investments.”
Bitcoin has had an environment that is easy to enact monetary policy, zero or negative interest rates for most of its 13-year existence. Although there is not a direct link between Bitcoin buy-orders placed on exchanges and Fed coffers, ProChain Capital’s president David Tawil believes there is one. One, any asset purchased by the Fed can cause ripple effects that lift prices and increase the value of other assets. He said that all of the buying power and all the investable power must go someplace.
Second, rates are at an all-time low. Investors have had to search the market for higher-yielding opportunities. Many turned to crypto due to its potential to make huge gains. Tawil said that a junk bond investor was used to getting high-single-digit returns on even the worst days. He will have to invest his money in something riskier, but he will also be forced to get something he is used to.
What happens when financial circumstances become more difficult? Tawil stated that the initial move is opposite to what occurred when they put money in. “Everything’s going to swing the other direction until it settles down,” Tawil explained. “That’s why there’s an immediate reaction in the market because everyone anticipates that the money will leave the more risky stuff.
In December 2018, U.S. central banking raised rates for the last time. This was its fourth increase in a string of hikes. Bitcoin was trading at $3,700 back then and concepts like “decentralized finance” or “non-fungible tokens” were still years away from becoming mainstream. It was a difficult year for the original cryptocurrency. Particularly towards the end, Bitcoin lost over 40% in the last two months. This period also coincided with a massive drop in U.S. stocks.
This dynamic is now playing out again, with Bitcoin falling along with highly-valued equities in advance of an expected new Fed tightening. Peter Boockvar is chief investment officer at Bleakley and editor of The Boock Report.
He said that the digital coin is currently only a risk-on/risk-off asset. “I expect it will trade with other risk assets as a response to Fed tightening.” Boockvar compared digital coins to Cathie Wood’s ARK Innovation ETF. This is considered “the ultimate risk asset” but has been highly sensitive to Fed tightening. Investors are starting to pay more attention to valuations.
Bitcoin is, however, a great shape-shifter. Since its inception, it has been a symbol of many things for many people over the past decade. Its (often contradictory!) narratives will continue to evolve. It’s been called dead many times, denounced as poisonous rats and labelled a bubble, only to be redeemed each time.
And as institutional adoption increases, Bitcoin’s future may also become clearer, says Max Gokhman, chief investment officer at AlphaTrAI, which is working on an application of its artificial-intelligence algorithms for the digital-asset space.
He said, “We shouldn’t discount the possibility that in future Bitcoin use cases might evolve to where it reinvents its self and gains importance again.”
