Key Takeaways
- Crypto is one year into a severe bear market
- This is the first time crypto has experienced a bear market alongside a weak broader economy
- With many negative macro variables and the zero-rate era over, it seems unrealistic to expect a significant crypto rebound in the near term
Anyone betting on a quick recovery in the crypto markets should reconsider.
If you follow my analysis, you know I have been bearish for some time. The primary reason is the macro backdrop: the economy is adjusting to a new paradigm of higher interest rates.
Crypto is among the highest-risk asset classes and was always vulnerable when the floor was pulled out from under risky markets. That is exactly what happened as Jerome Powell and the Federal Reserve tightened policy relentlessly.
Given this macro environment, there is a clear ceiling in place. Crypto is unlikely to rally until inflation is under control and interest rates have peaked. Treasury yields are trading around 4% now, and they could well rise toward 5% in early 2023.
There remains concern that inflation, though it appears to have peaked, could persist. The labor market has yet to show clear signs of loosening, while demand remains subdued but not collapsing.
More Bad News
This landscape led me to warn that crypto was potentially “one black swan away” from a meltdown. For a long time Bitcoin was stuck around the $20,000 level, unable to break out as the broader market’s bearish sentiment capped upside.
But I did not expect the shock to be so seismic. FTX’s collapse marks a turning point for crypto. I believe its damage will be greater than many currently anticipate.
We have already seen Moody’s put Coinbase’s debt on review for downgrade, a sign of the harmful fallout that exchange insolvencies can trigger. I analyzed the massive outflow of Bitcoin from exchanges after FTX and showed that trust had been shattered and was at record lows.
Remarkably, some 200,000 Bitcoins left exchanges less than a month after the FTX collapse. Even prominent investors have warned that institutional adoption could falter.
The old adage says “be greedy when others are fearful,” but I’m not convinced that applies here. Crypto is navigating unique challenges. It has never undergone a bear market while the broader economy was also weak — remember that Bitcoin launched in 2009 and until now has only weathered bull markets driven by ample liquidity.
Now the situation is different. Contagion is spreading, crypto’s reputation has taken severe damage, and the money printer no longer supports every asset class. These are tough times.
Previous Crypto Winters
In this context, the current environment is unprecedented for crypto. That’s why it’s naive to extrapolate past cycles onto today’s conditions. It’s much easier for crypto to rebound when interest rates are near zero and the broader economy is thriving. Not only that, but the scale of capital destruction this cycle may be larger given crypto’s massive growth during the pandemic years.
That said, there will come a time when inflation is beaten and rate hikes stop. This cyclical reality means risk assets will recover eventually.
I just believe this winter may last longer than many expect. Historical cycles show lengthy down periods as well. For example, after the near-$20,000 peak in December 2017, Bitcoin didn’t reclaim that level until the fourth quarter of 2020 — nearly a three-year stretch with no substantial gains for investors.
We are now one year into this bear market for both crypto and financial assets more broadly. Predicting the future in crypto is a risky endeavor and often ends poorly, but if I had to guess, I would be surprised if we are further than halfway through this bear market.
With winter tightening its grip across Europe, high energy prices biting, the war in Ukraine continuing, and inflation stubbornly persistent, it feels overly optimistic to expect crypto to rise soon.
Of course, circumstances can change quickly. A major positive development — for example a significant geopolitical de-escalation — could lift markets suddenly. Those shifts are impossible to forecast. My base case, however, is that we face a longer period of pain than many currently appreciate.