Cryptoverse: Buying the dip? Bitcoin’s a rates rookie
BITCOIN has scant experience with rising interest rates, posing perils for investors looking to capitalize on its dramatic drop.
The cryptocurrency has tanked along with other risk assets such as tech stocks after the Fed amped up rates last week, sending them on a trajectory that’s expected to pass 3 percent early next year.
Bitcoin was an awkward child on the fringes of finance during the Fed’s previous tightening cycle, from 2016 to 2019, and was barely correlated with stocks. The last time interest rates hit 3 percent, in 2008, it was but a gleam in the eye of Satoshi Nakamoto.
Crypto price moves are baffling at the best of time, let alone when the market’s entering uncharted waters, upping the risk level for traders pondering buying the dip.
Bitcoin fell to $29, 31 on Tuesday, its lowest level since July 2021, after dropping nearly 12 percent last week, its worst weekly loss since January.
“This isn’t the first time that we’ve reached this level, and the risk-reward ratio for picking up bitcoin here has been very good in the past year or so, but we are seeing a different macro backdrop,” said Matt Dibb COO of Stack Funds, a Singapore-based crypto platform.
“The concern is this time is different with respect to whether we will see continued weak sentiment in traditional financial markets, which is likely given the inflation outlook and the likelihood of increased rates in the next few months or years.”
The Fed’s rate rise of by 50 basis points last week was its largest in 22 years. Further 50 bps hikes are expected in both June and July, with the possibility of a fourth move in September according to CME group’s FedWatch tool.
“The era of free money is over. There’s a large adjustment of investor appetite happening right now,” said Chris Kline, COO and co-founder of Bitcoin IRA in Los Angeles.
Ether , the world’s second largest cryptocurrency fell to $2,360 on Monday, its lowest mark since February, and smaller coins, or “altcoins”, have sold off more aggressively.
“The more speculative altcoins are going to struggle, as we’ve seen in past volatile times in the crypto space. Bitcoin is considered risky, but some altcoins are at an even higher risk and those will have even larger sell-offs,” said Kline.
“The question mark is, will people see (crypto) as a diversification tool in bad economies? Or is it just something to have when times are good?”
It is not just crypto markets that are tumbling. Equity markets have also plunged as investors fear global central banks are willing to push economies into recession, if necessary, to rein in inflation. read more
“What’s interesting is that bitcoin itself hasn’t declined quite as much as the Nasdaq and some other asset classes, but the correlation has tightened between them. It’s certainly a higher correlation than we’ve seen in the past,” said Benjamin Dean, director of digital assets at WisdomTree in London.
The Nasdaq and S P 500 posted their fifth straight week of declines last week and the Dow Jones (.DJI) its sixth. It was the longest losing streak for the S P 500 since mid-2011 and for the Nasdaq since late 2012.
Crypto’s correlation with stocks is one reason for its recent crypto sell-off.
“We are getting feedback from investors in some family offices that are liquidating crypto because they are liquidating other assets, and they need to make it up on their book for this quarter to show that they’re not dying in everything and they’ve got some money on the side to get back into equities when they bottom out,” said Dibb of Stack Funds.
Some also note that sell-offs happen periodically in markets.
“From my perspective, two-way price action and occasional washouts are healthy for markets, including crypto,” said Brandon Neal, COO of Euler, a project that allows lending and borrowing of crypto assets. He added a note of caution, though. “We’ve never seen crypto in a recession, and it’s anyone’s guess what will happen.”
Compared with the Fed’s last tightening cycle which began in 2016 crypto is a much bigger market, raising concerns about its interconnectivity with the rest of the financial system.
In November, the most popular cryptocurrency, bitcoin, hit an all-time high of more than $68,000, pushing the value of the crypto market to $3 trillion, according to CoinGecko. That figure was $1.51 trillion on Tuesday. Bitcoin accounts for nearly $600 billion of that value, followed by ethereum, with a $285 billion market cap.
Although cryptocurrencies have enjoyed explosive growth, the market is still relatively small.
The US equity markets, for example, are worth $49 trillion while the Securities Industry and Financial Markets Association has pegged the outstanding value of U.S. fixed income markets at $52.9 trillion as of the end of 2021.
Cryptocurrency started out as a retail phenomenon, but institutional interest from exchanges, companies, banks, hedge funds and mutual funds is growing fast.
While data on the proportion of retail versus institutional investors in the crypto market is hard to come by, Coinbase, the world’s largest cryptocurrency exchange, said institutional and retail investors each accounted for about 50 of the assets on its platform in the fourth quarter.
Its institutional clients traded $1.14 trillion in crypto in 2021, up from just $120 billion in 2020, Coinbase said.
Most of the bitcoin and ethereum in circulation is held by a select few. An October report from the National Bureau of Economic Research (NBER) found that 10,000 bitcoin investors, both individuals and entities, control about one-third of the bitcoin market, and 1,000 investors own approximately 3 million bitcoin tokens.
Approximately 14 of Americans were invested in digital assets as of 2021, according to University of Chicago research.
While the overall crypto market is relatively small, the U.S. Federal Reserve, Treasury Department and the international Financial Stability Board have flagged stablecoins - digital tokens pegged to the value of traditional assets - as a potential threat to financial stability.
Stablecoins are mostly used to facilitate trading in other digital assets. They are backed by assets that can lose value or become illiquid in times of market stress, while the rules and disclosures surrounding those assets and investors’ redemption rights are murky. That could make stablecoins susceptible to a loss of investor confidence, particularly in times of market stress, regulators have said. read more
That happened on Monday, when TerraUSD, a major stablecoin, broke its 1:1 peg to the dollar and fell as low as $0.6 , according to CoinGecko. That move partly contributed to bitcoin’s fall. read more
Although TerraUSD maintains its tie to the dollar through an algorithm, investor runs on stablecoins that maintain reserves in assets like cash or commercial paper could spill over into the traditional financial system, causing stress in those underlying asset classes, say regulators. read more
With more companies’ fortunes tied to the performance of crypto assets and traditional financial institutions dabbling more in the asset class, other risks are emerging, say regulators. In March, for example, the Acting Comptroller of the Currency warned that banks could be tripped up by crypto derivatives and unhedged crypto exposures, given they are working with little historical price data.
Still, regulators overall are divided on the size of the threat a crypto crash poses to the financial system and broader economy.