After a meteoric rise in 2021, fueled by a hype train from both retail and institutional investors alike, cryptocurrencies have had a turbulent start to the year. Crypto seems to be crashing back down to Earth, and there are a few primary factors to blame.
Crypto and the stock market
What began with Bitcoin, alone on the fringe of the financial system, has evolved into an exploding ecosystem of more than 12,000 cryptocurrencies that are increasingly correlated with equity markets. So, if you find yourself asking, “Why is crypto falling today” the answer more than likely lies with the trends of the stock market.
In fact, from 2017 – 2019 Bitcoin had little to no correlation with stocks. Since 2020, however, that is no longer the case with the S&P 500 and Bitcoin seeing a 22% correlation in 2020 a 36% correlation in 2021.
Blue-chip crypto was initially pegged as a “risk-off” asset class – investments made due to a bearish outlook on the U.S. dollar or on the U.S. stock market more broadly. In theory, during a stock market correction, this type of asset class should benefit from a flight to safety.
But as the trends in 2020 and 2021 signaled, this may no longer be the primary investment thesis for crypto. Since the start of the pandemic and since trillions in economic stimulus were injected into markets, Bitcoin and other cryptocurrencies have very much become “risk-on” assets that move in tandem with stocks.
Why is the crypto market down?
Of course, cryptocurrency volatility is the result of much more than a correlation with the stock market. BTC, ETH, and other cryptos fluctuate due to a myriad of interrelated factors including supply and demand mechanics, government regulations, and rapidly changing user sentiments. And perhaps most relevant to the crypto crash of today is the expectation of increased interest rates.
As of March 16, 2022, the Federal Reserve officially raised interest rates for the first time since 2018. Fed officials lifted their key interest rate by 0.25%, and projected 6 more rate hikes in 2022 to combat recent inflation.
What happens to crypto when interest rates rise?
Historically low interest rates have stimulated the economy since The Great Recession. Cheap debt has meant extra money sloshing around in financial markets, fueling the performance of high-growth investments like tech stocks and cryptocurrencies.
As the prospect of higher interest rates becomes a reality, this process is starting to unwind. Future growth is less enticing, on a relative basis, when faced with higher borrowing costs today. And leveraged trades become more difficult to manage in sideways markets, removing some of the “extra” demand from the system.
Since the total crypto market peaked at over 3 trillion USD in November of 2021, the possibility of a “crypto winter” has begun to worry some cryptocurrency investors. But maybe crypto crashing isn’t all bad – even for crypto investors. A cooling off period may allow investors to accumulate, and the fundamentals of the network to catch up to the market.
Are we in a crypto winter?
Historically, Bitcoin’s price has been cyclical in nature – facing a number of blowoff tops prior to dramatic crashes of 80% or more. In between these peaks, however, every bull run has experienced a number of meaningful downturns.
According to Peter Brandt, “During the 2015-2017 bull market in Bitcoin $BTC, there were 9 significant corrections with the following averages: 37% decline from high to low, 14 weeks from one ATH to the next ATH”.
Until we see a sustained drop below $30,000 per BTC, representing a move of more than 55% from the all-time high of $68,990.90 (according to Coindesk), Bitcoin appears to remain within normal correction territory.
Will Bitcoin crash below $20,000?
While we have seen several 80% retractions from Bitcoin in the past, a similar decline from Bitcoin’s recent peak would imply a price below $15,000. Nothing is off the table in crypto, but such a scenario is far less likely than it once was.
One of the most notable changes in circumstance during crypto’s recent run up was more widespread adoption, especially among institutional investors. These investors are less likely to exit emotionally or to jump between cryptocurrencies. They also have significantly more firepower to “buy the dip” and support prices.
As businesses and financial institutions continue to allocate a portion of their portfolio to crypto, large chunks of supply should change hands less frequently and volatility should be slowly reduced over time.
Crypto crash flushes out momentum traders
When looking at why crypto is crashing this year, it’s hard not to consider the implications of 2021’s retail investing craze. With stimulus checks in hand, meme-stock traders were born from the depths of Wall Street Bets and FinTwit. Yoloing into any investment that was mooning, momentum chasers successfully rode hot trends including cryptocurrencies like Bitcoin, Ethereum, Doge (sigh), and more.
But as trends reverse, these “momo” traders are the first to pull their funds in search of the next craze. These sellers create a temporary downward pressure on price… until the “diamond hands” crowd steps in to accumulate.
“Diamond hands” support the price of crypto
Perhaps the greatest bull case for Bitcoin is the number of buyers that have never sold. Due to the public nature of the blockchain, we can see exactly how many wallets have purchased crypto, at what prices, and when and if they sell.
Recent estimates from Delphi Digital explain that more than 20% of BTC hasn’t moved in over 5 years, despite wild fluctuations in price. As crypto utility drives greater adoption and in turn greater demand, these long term “hodlers” along with the supply mechanics of Bitcoin create a strong bull case for the price of BTC.
In fact, this type of analysis led legendary investor Stanley Druckenmiller to invest in Bitcoin in the spring of 2020 despite previously referring to it as a “a solution in search of a problem”.
Billionaire macro investor Paul Tudor Jones changed Druckenmiller’s mind with one simple statistic. During the Bitcoin crash of 2017, when the price plunged from $17,000 to $3,000, 86% of Bitcoin owners never sold. Druckenmiller said this combination of “finite supply” and “religious zealots” could not be ignored.
Why is crypto falling today?
With markets reaching all-time highs in nearly every category in 2021, it has been easy to get caught up in speculation and the idea of easy money. As we settle into a period of consolidation, it’s best to reassess your original thesis for investing in cryptocurrencies.
Ask yourself: Have my reasons for investing in crypto changed? Has my original narrative been disproven? Was there a fundamental shift that I need to rethink?
If your answers are “no”, then it’s best to not get caught up in day to day price action. Crypto is volatile, and crypto is young. As adoption continues, regulations are sorted out, and budding web3 platforms battle for attention, we will continue to see huge price swings.
As investors, daily variation in sentiment is not what’s important. Asking why crypto is crashing today is a surefire path to an emotional reaction rather than an informed decision.
