Crypto Diehards Are About to Find Out If It Really Was a Bubble

(Bloomberg) – For true crypto believers, Bitcoin is the ultimate store of value, the strongest hedge against rampant inflation manufactured by reckless central banks and their money printing. To skeptics, the crypto world as a whole is a mirage whose massive rise of over $ 2 trillion was simply the speculative by-product of the extraordinary amount of easy cash that has been circling the global economy; indeed, a big bubble.

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Both theories are about to face their biggest test yet.

Bitcoin, the original cryptocurrency, emerged more than a decade ago from the ashes of the global financial crisis as a detour to banks and government agencies mired in the great Wall Street calamity at the time. The digital token steadily gained a following, inspired a number of hopefuls, and endured some wild rides. But it wasn’t until the next big crisis, Covid-19, that the market really took off.

Cryptocurrencies exploded after March 2020, when the Federal Reserve and Congress unleashed trillion-dollar stimulus to mitigate the economic blow of the pandemic. A lot of that money made its way into digital assets, driving up prices. Bitcoin skyrocketed 305% in 2020 and gained another 60% the following year, breaking a record of nearly $ 69,000 in early November. Since then, however, it has been on a relentless slide, weighed down in large part by the aggressive pivot of the central bank. Now, with the increasing odds that policymakers will begin a series of rate hikes as early as March, just one of several steps they need to take to eliminate liquidity, it remains to be seen whether the crypto ecosystem can endure without it.

Not looking good so far: Bitcoin is already down 40% from its highs, while the number 2 coin Ether and other “altcoins” have also suffered sharp declines.

“If they’re going to raise rates three times in 2022 and stick with the program, and the era of low rates is over, we’ll really see how much people believed in their Bitcoin crypto thesis,” Stephane Ouellette said. CEO and co-founder of crypto platform FRNT Financial Inc. “I would expect the Fed to become increasingly aggressive, it is very bad for valuations.”

Michael O’Rourke, JonesTrading’s chief market strategist, agrees. “Seemingly perpetual asset purchases by the Federal Reserve have been the cornerstone of cryptocurrency investing,” he said. If the central bank follows the path outlined in its latest release of minutes, which showed that Fed officials are prepared to move faster than expected to raise interest rates and potentially lower the bank’s balance sheet, then “that would undermine immediately the key bullish thesis behind Bitcoin and many other cryptos, ”said O’Rourke.

For most of its 13-year history, Bitcoin has enjoyed a loose monetary policy environment and zero or negative rates. While there is no direct line from Fed coffers to Bitcoin buy orders on exchanges, there is a connection, according to David Tawil, president of ProChain Capital, a crypto hedge fund. On the one hand, the purchase of any type of asset by the Fed can have a domino effect and raise the prices of other investments. “All the purchasing power, all the investment power that exists has to go somewhere,” he said by phone.

Second, with rates at lows, investors have been forced to scour the market for higher-yielding opportunities, with many turning to cryptocurrencies given their ability to post gargantuan profits. Think of a junk bond investor who was used to high single-digit returns even on bad days, Tawil said. “You will be forced to invest money in something ‘riskier’, but more importantly, in something that produces something that you are used to achieving.”

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So what happens when financial conditions get tighter? “The initial move is the opposite of what happened when they put the money in, everything will go away and move the other way, until it calms down,” Tawil said. “That’s why you have this immediate reaction in the market because everyone is anticipating that the money will make things riskier.”

The last time the US central bank raised rates was in December 2018, its latest increase in a series of hikes. Back then, Bitcoin was trading at around $ 3,700 and concepts like “decentralized finance” and “non-fungible tokens” were years away from entering the vernacular. It turned out to be a difficult year for the original cryptocurrency, particularly towards the end, when Bitcoin lost more than 40% over the past two months, a period that also coincided with a beating in US stocks.

That dynamic is playing out again now, with Bitcoin falling in step with high-value stocks ahead of another expected round of Fed tightening, says Peter Boockvar, chief investment officer at Bleakley Advisory Group and editor of The Boock Report.

“For now, it is proving to be just a risk asset with / without risk,” he said. “I hope it will trade other risk assets in response to the Fed tightening.” Boockvar compared the digital currency to Cathie Wood’s ARK Innovation ETF, which is considered “the highest risk asset” and which has also proven highly sensitive to the Fed’s tightening as investors begin to pay more attention to valuations. .

Bitcoin, however, remains a supreme shape shifter. It has represented many things to many people for over a decade and its (often conflicting) narratives will continue to evolve. After all, he’s been dismissed time and again as dead, denounced as rat poison, and punished like a bubble only to come back stronger and stronger.

And as institutional adoption increases, the future of Bitcoin may also become clearer, says Max Gokhman, chief investment officer at AlphaTrAI, who is working on an application of its artificial intelligence algorithms to the digital asset space.

“We should not rule out that future use cases for Bitcoin may evolve to where it reinvents itself and gains importance again,” he said.

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