Is Crypto Headed Towards a “Crash” in 2022?

The onerous jokes about 2022 being “2020: Part 2” are a dime a dozen on the internet.

And if one were to consider the crypto state of affairs then it seems that the joke might have been right on the money.

The year’s beginning has been tough on the crypto market. Yesterday, Bitcoin prices tumbled below $43,000. The current slump has been in the offing since November 2021 when it last hit its all-time high above $69,000.

Although the current prices aren’t as low as last September, they hint towards increasing volatility in the asset, giving a lift to rising investor scepticism. Over the last few months, trading volumes have dried up, open interest on future contracts has plummeted (39% since October 2021) and active addresses (i.e. Bitcoin wallets and related transactions) have stalled out.

There’s an overall malaise surrounding the asset class which some in the past have described as “lacking fundamental value” and serving “as more of a toy” than an investment.

So what? Considering that it’s cryptocurrency, isn’t this the sort of volatility one would expect in the market — long moments of sideway boredom interrupted by days of sheer terror?!

Perhaps, yes. And perhaps the ongoing sellers’ frenzy is momentary at best, especially when institutional patronage for Bitcoin is on the rise (yesterday, Goldman Sachs predicted Bitcoin to scale the $100,000 mark in the next five years!).

Nevertheless, the global cryptocurrency market cap’s erosion by over 7% in the past 24 hours is something that merits analysis. We bring you ours right here.

Recap of Yesterday’s Slump

Bitcoin bled red with its market cap plunging below $815bn. Considering that it is the Pied Piper of cryptocurrencies, when it goes down others fall like dominos. Not only did the altcoins take a hit in prices but so did stablecoins and digital tokens.

Now, this downtrend has been well-established since November’s “flash crash”. Barring a few intermittent surges after the launch of the world’s first Bitcoin ETF, trading activity in crypto has trailed off amid weak global cues which dragged the markets to a bear-run towards the end of 2021.

However, yesterday’s selloff could be attributed to some new and stand-out actors.

The Glitter’s Coming Off

The most prominent actor is the US Federal Reserve. The Fed released the minutes of its December meeting which showed policymakers discussing the possibility of quicker interest rate hikes in the coming days in an effort to try and shrink the central bank’s $8.3trn-large balance sheet.

Here’s how a hawkish Fed policy weighs down on crypto markets. Bitcoin is often considered by experts to be a “hedge against inflation” because its supply is limited to 21 million unlike fiat currencies whose supply isn’t capped. So if the supply of the US Dollar increases and that of Bitcoin’s remains the same, the latter’s value vis-a-vis the former should increase, ceteris paribus.

But one must also remember that Bitcoin is a risky asset. And while easier monetary policies enable investors to make risky bets, tighter policies (like the Fed deciding to pull liquidity from the markets and making it harder to get credit) could make risky bets like Bitcoin riskier and less attractive.

The Fed’s policy also affected Bitcoin prices indirectly via another route. There was a time when cryptocurrency, irrespective of its regulatory uncertainty and volatility, had an edge over other investments due to its detachment from traditional financial systems.

But as more and more institutions and companies pump money into cryptocurrencies, Bitcoin’s “safe-haven” characteristic loses its sheen. The Fed news amplified this narrative as the US equity markets deepened in losses in tandem with crypto markets, hinting at their parallel movement and eroding the latter’s identity as a drifter asset class.

There were additional factors behind the slump, such as Kazakhstan, a country which is home to as much as 18% of the world’s Bitcoin mining power and has been under widespread internet shutdown following the recent anti-government protests.

And then there are altcoins, the “Bitcoin-plus” digital currencies, which are diverting the interests of investors and creating a more competitive market for the numero uno. The rising excitement over second-tier coins and tokens, cemented in part by social media hysteria and celebrity antics (yes, it’s you, Mr. Musk!) has the potential to make selloffs like this more pronounced in the long-term.

Where is the Market Headed?

Even Mr. Buffett opts for plausible deniability when asked a question like that. ;) And frankly, he’s right. Because nobody knows.

What we do know, however, is that this won’t be the last time the markets bleed. And even though trading has ebbed, the recent drops have only caused investors to trade more, as per some analysts, with trading volume in Bitcoin standing at a record high of $540bn in the fourth quarter of 2021. This bodes well for other crypto stakeholders like exchanges (Coinbase, WazirX etc.). So, the ongoing pessimism may be misplaced to some extent.

Another case in point is the buying-into-the-dip frenzy which seems to proliferate during market corrections like these offering an attractive entry point, especially for first-time investors. Though, after a washout of this scale, it could be a while before the existing losses are replenished with new capital.

And then there are those whose trust and support in cryptocurrencies remains unabated despite any selloff. MicroStrategy, a firm known to build its fortunes disproportionately on crypto gains, added a new chunk of Bitcoin ($94.2m) to its purse at the year’s end.

With whales carrying on their buying spree and traditional banks becoming more receptive to crypto usage, Bitcoin’s ability to recover from yesterday’s losses can’t be understated. In fact, many also believe that the current selloff is merely a sign of “rotation” in investments. For every asset class, money changes hands between retail and institutional investors in cycles following a significant bear or bull run. So, what we witness right now, could be a rotation of money from retail investors to institutional investors, and the resulting selloff is an offshoot.

So, perhaps, don’t be too quick to worry if your portfolio has run into red. When more and more analysts opine that Bitcoin will steal market share from gold in the future, one can be rest assured that the risk-off moves by crypto investors are yet to rise to a worrying degree.

(Originally published January 6th 2022 in transfin.in)