Why is crypto going down?

Why is crypto going down?

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The price of Bitcoin (BTC) has been dropping sharply over recent months, thanks to major turbulence in cryptocurrency markets.

As of this writing, BTC is hovering around $20,000, down 32% on the month. This is a major break lower from the $28,000 to $32,000 range the benchmark crypto had been seeing since early May.

On June 27, Three Arrows Capital (3AC) defaulted on a loan from Voyager Digital, worth about $350 million in crypto assets. The loan was made up of USD Coin (USDC) and roughly 15,250 BTC. 3AC was a major backer of TerraUSD/LUNA, the epicenter of last month’s stablecoin meltdown.

To make matters worse, the Financial Times reported earlier this month that Genesis and BlockFi liquidated some of 3AC’s positions.

3AC has plunged into liquidation. As of this week, a court order made in the British Virgin Islands is calling for 3AC to liquidate, deepening the unfolding crypto crisis.

Bitcoin prices are now down nearly 60% year to date, trading well off their all-time highs of around $69,000 in November 2021. Experts also say that BTC is no longer viewed as an inflation hedge, trading in lockstep with equities, which are also in a downturn.

Total cryptocurrency market capitalization is now a touch below $900 billion, according to data from CoinMarketCap.com. Crypto markets, experts say, are overleveraged and liquidity remains tight.

Several other crypto companies have faced liquidity crunches recently. For instance, the run on money at crypto lender Celsius, which paused customer withdrawals earlier this month because of “extreme market conditions.” Celsius has kept customer withdrawals and transfers frozen since June 13, at risk of insolvency.

Bank Run on Crypto Lender Celsius

Celsius, a decentralized finance (DeFi) platform and one of the largest crypto lenders was a big source of negative Bitcoin market sentiment in mid-June.

With up to 1.7 million customers, Celsius earned a cult following in the crypto world by advertising that users could earn an annual percentage yield (APY) of up to 18% by depositing their crypto holdings on the company’s platform.

The company takes crypto deposits and loans them out to other investors and financial institutions in a process analogous to conventional bank lending. Users earn yield from the revenue Celsius generates from crypto borrowers.

The company had $11.8 billion worth of assets under management (AUM) as of May 17, down from more than $26 billion in October last year. In June, the company stopped disclosing its total AUM on its website.

In a statement released earlier this month, the company disclosed pausing crypto withdrawals.

“Due to extreme market conditions, today we are announcing that Celsius is pausing all withdrawals, Swap, and transfers between accounts. We are taking this action today to put Celsius in a better position to honor, over time, its withdrawal obligations.”

While a user’s Celsius looks and feels a lot like a conventional bank account and even uses terms that make the account appear to work similarly to a bank account, the company is careful to disclose that it is, in fact, no such thing.

“Your Celsius account is not a bank account, deposit account, savings accounts, checking account, or any other type of asset account and should not be characterized as a banking product or service,” Celsius says in its terms of use.

Bitcoin Had a Rough Start to 2022

Bitcoin ended 2021 up nearly 70%. That’s a fantastic return for any asset class, let alone one without any tangible value or the full faith and credit of a national economy behind it.

Nevertheless, a 70% annual return represents a comedown for Bitcoin after gaining more than 300% in the lockdown-ravaged year of 2020.

In 2022, investors are in a risk-off mood, embracing “a general flight to safety across the board in most asset classes,” said Alex Reffett, co-founder of wealth management firm East Paces Group. “Collectively, investors have shown more interest in value-based investments and less in speculative stocks and alternative ‘store of value’ investments.”

One reason is the Federal Reserve, which has already raised interest rates three times this year and is poised to raise them again in July.

The Fed is fighting a historic surge in inflation that rivals anything seen in the last four decades. Just how many hikes remain is unclear, but analysts expect the central bank to keep raising rates through the end of the year and into 2023. The fed funds rate could end the year at 3.5% or above by some estimates.

When the Fed raises interest rates, it lessens demands for more growth companies—like tech stocks—and speculative risk assets—like cryptocurrencies and Bitcoin.

Judging how much demand for crypto will remain with all the liquidity drying up is an open question.

“We have no historical precedent for how Bitcoin and other cryptos might act if we enter a sustained period when central banks actively drain liquidity,” said Interactive Brokers’ chief strategist Steve Sosnick. “Those tend to be difficult times for investors, and riskier assets tend to underperform safer ones.”

Bitcoin Is a Risk Asset

Risk assets are investments that experience a significant amount of volatility in the usual course of the market.

Stocks, commodities, high-yield bonds, currencies—and Bitcoin—are risk assets because you can expect their prices to move up and down frequently under almost any market conditions.

Until recently, Bitcoin was considered a store of value that was somewhat immune to fluctuations in the value of risk assets. That’s no longer the case. Today, Bitcoin and the broader crypto market are influenced by economic phenomena that move the value of risk assets—things like inflation, stock markets and Fed monetary policy.

“The reason that this particular decline is occurring this year is because market narratives have shifted from risk-on to risk-off,” said Richard Smith, author of the Risk Rituals Newsletter. “Liquidity is drying up as the Fed and other central banks start to taper excess stimulus.”

Experienced Bitcoin traders are no strangers to bear markets. The price of BTC fell more than 80% in the 2017-2018 period. But that was before major corporations, like Fidelity and PayPal, invested billions in getting into the crypto game.

Fledgling crypto owners should know how much nerve is required to stick with Bitcoin over time.