Bear markets have grown almost routine for Bitcoin and other cryptocurrency prices. Since its 2009 launch, Bitcoin’s price has tumbled more than 50% six times.
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Coinbase (COIN) CEO Brian Armstrong, in a June 14 letter announcing an 18% staff cut, offered assurance despite the latest Bitcoin crash and walloping of other crypto prices. Armstrong said the cryptocurrency exchange “has survived through four major crypto winters” and is taking the steps needed to do so again.
Yet this storm is on an entirely different level. “It’s a crypto ice age,” Mizuho analyst Dan Dolev told IBD. “I think this is going to be very deep, very prolonged, and many cryptocurrencies will not survive.”
The blowup of supposed “stablecoin” TerraUSD, wiping out $40 billion in market value, has accelerated a deleveraging wave that has yet to run its course. This month, crypto lending platform Celsius Network, which oversaw $20 billion in crypto deposits and loans, halted withdrawals as it faced a liquidity crunch.
Both Terra, a blockchain payment and savings network, and Celsius offered double-digit interest payments that depended on bullish crypto scenarios. But the collapse of those Wild West business models is less a cause than a symptom of crypto’s unraveling. The real reason the cryptocurrency market is imploding: Bitcoin and the other roughly 19,000 digital currencies are up against their first Federal Reserve tightening cycle to stem an inflation outbreak.
Easy Money Fueled Cryptocurrency Prices
For most of their existence, cryptocurrencies have enjoyed the balmiest of monetary conditions. The period since Bitcoin’s launch has mostly seen the Fed trying to prop up demand. Over that time, the Fed bought up $6.5 trillion worth of Treasuries and government-backed mortgage securities. That suppressed rates in a bid to encourage risk-taking, boost asset values and stimulate demand through wealth gains.
The bulk of those Fed purchases — $4.5 trillion — came after the coronavirus lockdown cratered the economy in March 2020. Alongside multiple rounds of fiscal stimulus, ultra-easy Fed policy worked only too well. All that monetary fuel supercharged the vaccine-enabled economic reopening and touched off the biggest bout of inflation in 40 years.
Now the reversal of unprecedented Fed stimulus is deflating most asset values. The surge in the 10-year Treasury yield has hit growth stocks in particular. Their future earnings streams are less valuable when discounted to the present based on a higher risk-free rate of return. That helps explain why the tech-heavy Nasdaq has underperformed the broad market.
But when it comes to valuing Bitcoin and other cryptocurrencies, there are no future cash flows to discount.
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Bitcoin Crash Shows It’s No Digital Gold
The Bitcoin crash has “debunked” the idea that it offers a hedge vs. inflation, like digital gold, Deutsche Bank economists Marion Laboure and Galina Pozdnyakova wrote in May. Rather than trading like gold, the ups and downs of cryptocurrency prices have correlated with the Nasdaq to a “staggering” degree, they wrote.
Yet cryptocurrency’s roller-coaster ride makes the Nasdaq’s volatility seem tame. Through June 23, the Nasdaq is down nearly 31% from its Nov. 22 intraday high. Bitcoin, which peaked on Nov. 10, has dived 70%.
Fed Rate Hike And Other Tightening Moves
Just days before Bitcoin began its retreat, the Fed said it would scale back $120 billion in monthly asset purchases. The timing doesn’t appear to be a coincidence. In fact, the history of Bitcoin’s peaks and valleys mostly coincides with shifts in Fed asset purchases.
The first Bitcoin crash began in June 2011, just as the Fed ended its second round of financial-crisis-era asset buys. The second coincided with the spring 2013 taper tantrum over a possible wind-down of yet-another round of asset purchases. The start of actual tapering at the end of 2013 coincided with the third Bitcoin crash.
The late 2017 crash coincided with Federal Reserve rate hikes that came as the Fed began to gently unwind asset purchases. Yet none of those instances saw anything like today’s tightening.
In late 2018, when monetary tightening helped trigger a financial market rout, the Fed’s key interest rate only reached 2.5%-2.75%. That was the highest in Bitcoin’s history. Yet once the S&P 500’s drop approached the 20% bear market threshold, Fed policymakers signaled a change in course. By autumn 2019, the Fed was cutting rates and buying more assets.
But last week, though the S&P 500 and Nasdaq had already crossed into bear market territory, policymakers decided to accelerate their tightening plans.
The Fed doesn’t target any specific asset class. However, the $2 trillion wipeout for cryptocurrency markets is all according to plan.
“We’ve seen financial conditions tighten and appropriately so,” Fed chief Jerome Powell said June 15.
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Bitcoin Price Has Crossed This Line
In recent days, this Bitcoin price crash crossed a line that previous bear markets in cryptocurrency prices didn’t even approach.
Bitcoin tumbled as much as 75% from November’s record $68,990.90 to the June 18 low near $17,800. That briefly undercut its last major peak near $19,600 in December 2017. At its worst, in early 2015, Bitcoin’s low was nearly 40% higher than the previous peak.
Bitcoin has since bounced to just above $21,000. That’s right around the average $21,000 purchase price, Mizuho’s Dolev says.
Wiping out Bitcoin’s gains over the past 4.5 years is challenging the notion that long-term holders can’t lose. That will test the faith that ultimately determines the value of all cryptocurrencies.
That faith probably has limits, yet it clearly runs deep. Nearly 50% of Bitcoin traders on Coinbase say they won’t sell, no matter how low cryptocurrency prices go, Dolev wrote on May 19. “For the remaining ~50%, the tipping point is about $9,000,” a Mizuho survey found.
Despite the cryptocurrency price carnage, Silicon Valley VC firm Andreessen Horowitz announced a $4.5 billion crypto fund on May 25. Venture firms plowed $4.2 billion into early-stage crypto firms last month, a sizable sum, though down from $6.8 billion in April. In 2021, VC funding of blockchain firms totaled $33 billion.
Cryptocurrency’s Killer App?
What have all those billions bought? The main excitement, if not the primary purpose, of cryptocurrencies seems to be digital alchemy — creating money out of code.
No doubt, creating nearly $3 trillion out of code — then erasing $2 trillion — was an incredible feat.
NFTs, or non-fungible tokens, may be the closest thing to a killer app. NFT ownership is tracked on the same blockchain ledgers that record ownership of cryptocurrencies. The tokens can provide ownership to digital art, sports cards, music videos and the like.
But these digital collectibles may have even flimsier support than the cryptocurrencies.
The digital rights to the first-ever tweet famously sold for $2.9 million in March 2021. When put up for auction a year later, the top bid came in around $12,600.
The most expensive NFT sale over the past month was a digital print from the Bored Ape Yacht Club collection. Owning one of the 10,000 images has become a pseudo status symbol. Club members include Jimmy Fallon and Justin Bieber.
Yet Bored Apes’ valuations have plunged. The floor price — the lowest current auction price for part of the collection — has crashed 77% since the May 1 peak of $420,000, to about $97,250.
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Crypto Payment Functionality Revisited After Bitcoin Crash
What separates Bitcoin and most other cryptocurrencies from being mere collectibles is their utility for conducting transactions.
Progress on that front has been slow. In 2014, Stripe was the first major payments firm to support Bitcoin transactions. By 2018, it had cut off that support, citing slow transaction times, high fees and little customer interest.
Four years later, Stripe has rekindled its Bitcoin ties, while some crypto players are winning plaudits for transaction efficiency.
In April, Morgan Stanley touted Bitcoin’s Lightning Network as more practical for retailers than debit cards for small purchases. The secondary network allows for fast, low-cost transactions between off-network parties.
These transactions don’t require Bitcoin’s slow, costly, energy-intensive proof-of-work calculations to update the blockchain ledger. The Lightning Network works more like Visa (V) and Mastercard (MA), allowing for funds settlement after the transaction is complete.
Ethereum is gearing up to shift its entire network to the same kind of lightning-fast transactions, while cutting energy use by 99%.
In April, Lightning Labs, the team behind Bitcoin’s Lightning Network, announced $70 million in funding. Its new big project is to enable the network to handle transactions via stablecoins backed by fiat currencies such as the dollar.
Yet if paying with $1 stablecoins makes more sense than using Bitcoin, why should Bitcoin be valued at $20,000 or more?
“I’m a big believer in blockchain technology and smart contracts and decentralized finance,” Dolev said, citing the potential to reduce the cost of transmitting money globally. “But I make a big distinction between all these things and the hype around the coins.”
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Stablecoin Cryptocurrency Price Test
Stablecoins have been the biggest winners and losers of the latest crypto crash. Tether and USD Coin, now the third- and fourth-largest cryptocurrencies by market cap, have held essentially 100% of their value.
The coins’ value is backed by an equal amount of extremely safe assets like cash and U.S. government debt. Tether also holds short-term high-rated commercial debt. Amid crisis, they have had liquid cash at the ready to cover withdrawals.
When the TerraUSD stablecoin faced an old-fashioned bank run in May, the collateral for some $18 billion in coins was composed of other coins. That included more than $20 billion worth of Luna coins issued by the same company. Yet when push came to shove, Luna turned out to be worth next to nothing. TerraUSD broke its dollar peg on May 7, crashed to 15 cents within a week and is now worth a fraction of a penny.
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Cryptocurrency Regulation
In some respects, stablecoins are like a crypto version of money market funds, a safe place to park cash for a modest return. But the returns weren’t modest and investors’ cash wasn’t safe in the case of TerraUSD.
While the going was good, TerraUSD holders enjoyed a 20% interest rate. That should have been a red flag.
But even money market funds struggled during the 2008 financial crisis, with the Primary Reserve Fund famously “breaking the buck.” The Securities and Exchange Commission followed with reforms requiring funds to hold more liquid assets and stress-test for crisis situations.
Something along those lines could be coming for stablecoins. That would kill off algorithmic funds such as TerraUSD that are backed by nonstable cryptocurrencies. Regulators might also impose limits on the interest paid by stablecoins.
While it’s unclear whether Congress will pass legislation regulating crypto, SEC Chair Gary Gensler has made the case that most coins are securities and already fall under the agency’s authority.
Bitcoin Crash And The ‘Wild West’ Crypto Market
Gensler compared crypto to the Wild West in a speech last August, calling it “rife with fraud, scams and abuse.” He began taking steps to rein in those practices well before the latest blowups.
Last September, Coinbase said the SEC threatened to sue the company, forcing it to shelve its about-to-launch Lend program. Coinbase had planned to offer 4% interest to customers who deposited stablecoins for lending out to others. The SEC said the stablecoin deposits amounted to an investment in a security because Coinbase doesn’t fall under banking regulations, with leverage restrictions and deposit insurance.
In February, BlockFi agreed to pay $100 million in fines after the SEC charged that its interest accounts for those who deposited crypto qualified as unregistered securities. Further, the SEC said BlockFi was operating as an unregistered investment company because it had more than 40% of assets in investment securities, including loans of crypto to institutional borrowers.
Reportedly, similar investigations were aimed at crypto lender Celsius and its 18% interest rate. But they didn’t come soon enough to prevent this month’s train wreck. Celsius raised $750 million in funds from investors last fall, but it still had to halt withdrawals as the crypto sell-off intensified after the crash of the TerraUSD stablecoin.
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Cryptocurrency Prices Hangover
If you’re wondering whether cryptocurrencies are a good bet at recent crypto prices, keep in mind that the mania has only just begun to break. While Bitcoin peaked in November, the Luna cryptocurrency that was supposed to keep TerraUSD pegged to the dollar only peaked in April — before crashing to zero the next month.
The unwinding of excessive leverage, more regulatory scrutiny and a Federal Reserve tightening cycle meant to douse speculative fervor suggest a long crypto winter. A lot of business models that seemed viable and investments that seemed rational when crypto had never suffered a long losing streak are facing their first major reality check.
To some Bitcoin believers like MicroStrategy (MSTR) CEO Michael Saylor, who bet $4 billion of company funds on the cryptocurrency, the shakeout is overdue.
“What you have is a $400 billion cloud of opaque, unregistered securities trading without full and fair disclosure, and they are all cross-collateralized with Bitcoin,” Saylor said in an interview hosted by the Northman Trader market analysis site.
The implication is that shady practices across the crypto sphere and the cascading margin calls they’ve provoked are responsible for the latest Bitcoin crash. All those other cryptos also undermine Saylor’s notion that Bitcoin is a scarce resource. Bitcoin’s market cap now accounts for about 45% of total crypto value, down from 90% at the start of 2016.
What Will Follow The Ice Age In Cryptocurrency Prices
Saylor’s perspective may shortchange the role of Fed tightening and the extent to which the need for collateral to fuel crypto speculation helped boost Bitcoin’s price.
Yet inflation will eventually recede, and the Federal Reserve will end its tightening cycle. But the central bank is unlikely to return to a sustained super-easy monetary policy anytime soon.
A new crypto spring will eventually arrive. Just don’t expect it to be anything like the prior ones.
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