The “bullish” trend of the crypto market is far from over
A bad start to 2022
Volatility is a distinctive feature of cryptocurrencies
Inflation will continue to cause the depreciation of fiat currencies
Fintech and Inflation: Cryptocurrencies Offer an Alternative
Bitcoin and ether will form the bottom, the bull market is not yet complete
At the December FOMC meeting, the Federal Reserve decided not to call the observed increase in inflation “transient” in the future. After President Biden appointed Jerome Powell to a second term as Fed chairman, as well as following the publication of the latest inflation data, the central bank accelerated the curtailment of quantitative easing, paving the way for an increase in the federal funds rate from near zero in March 2022.
At the beginning of this year, the central bank also hesitated in its intentions regarding the reduction of the balance sheet. And yet, the minutes of the Fed’s December meeting showed that a transition from quantitative easing towards quantitative tightening is not excluded in the coming months.
Inflation leads to the depreciation of fiat currencies, reducing their purchasing power
If we talk about the dollar, euro, pound, yen and other fiat currencies, the value of which is based on full confidence in the governments issuing them, then their depreciation is not so obvious when comparing one currency market instrument with another. If we compare them with stocks, commodities, real estate and cryptocurrencies, then their value really fell in 2021.
Cryptocurrencies are an alternative to existing currency instruments, embodying a libertarian economic ideology. Central banks, treasuries, monetary authorities, and governments can ease or tighten monetary policy to influence the money supply. With cryptocurrencies, everything is different. The value of digital currencies depends on the level of supply and demand determined by market participants without government intervention. This means that inflationary pressure probably caused the market capitalization of this asset class to increase by more than 180% in 2021.
Market rallies rarely have a straight trajectory, and corrections are sometimes swift and merciless. Price movements in such an extremely volatile asset class as cryptocurrencies are nothing short of dizzying. The crypt has so far started the New Year on a “bearish” note.
A bad start to 2022
The leading cryptocurrencies and the total market capitalization of this asset class began to decline on November 10, and at the beginning of 2022, the downward trend continued.
Bitcoin — Daily Timeframe Bitcoin — Daily timeframe
As you can see on the chart, on November 10, a bearish “key reversal” pattern formed on the chart of January bitcoin futures: the price that day reached a maximum of $69,820, but the closing was below the minimum of the previous day. Trading on December 31, 2021, futures ended at $46,275, and at the end of last week, the leading cryptocurrency was trading at $43,330 — 37.9% below the maximum on November 10.
Futures on ether – daily timeframe Futures on ether – daily timeframe
January ether futures peaked at $4,972.75 on November 10, then formed the same “bearish” pattern and ended 2021 at $3,685. By January 14, Ethereum was trading at $3,340 — 32.8% below the record peak recorded in mid-November.
The total market capitalization of cryptocurrencies reached $2.166 trillion on December 31. By January 17, it amounted to $2.091 trillion, having decreased by 3.5% over the past period of 2022. Bitcoin and ether have lost 6.4% and 9.4% respectively since the beginning of the year. The leading cryptocurrencies showed dynamics worse than the general one — other tokens are doing better this year.
Volatility is a distinctive feature of cryptocurrencies
Investors have already become accustomed to sharp price fluctuations in the cryptocurrency market, where assets regularly double or even triple in price, and sometimes lose more than half of their value at once.
Bitcoin — Weekly Timeframe Bitcoin — weekly timeframe
As can be seen on the weekly chart of bitcoin futures, the weekly historical volatility in 2021 ranged from 42.57% to 128.50%. As of January 14, this indicator of price volatility was 50.9%, being closer to the minimum than to the maximum for the period since the beginning of 2021.
Ether — weekly timeframe Ether — weekly timeframe
Ether futures trading began in February 2021. From February to December 2021, the weekly historical volatility for the ether fluctuated within the range of 38.92–149.95%. As of January 14, the indicator was 49.7%, also being closer to the minimum.
The decrease in volatility indicates the consolidation of the leading cryptocurrencies after the rollback from the highs of November 10. And although both of them showed lower lows at the beginning of 2022, the dynamics in general have acquired a calmer character while prices are recovering from recent lows.
Inflation will continue to cause the depreciation of fiat currencies
As the US Federal Bureau of Labor Statistics reported last week, the US consumer price index in December 2021 increased by 7%. Core inflation, excluding food and energy prices, was 5.5%. The Fed’s target level for inflation is 2%. The producer price index increased by almost 10% in 2021.
The central bank has accelerated the curtailment of the quantitative easing program, which, apparently, will now be fully completed in March 2022, which sets the stage for raising the federal funds rate from near zero. Moreover, the Fed has begun to discuss reducing its balance sheet, in which debt obligations will be withdrawn from the bloated balance sheet of the central bank upon maturity. This will mean that the Fed has switched from quantitative easing to quantitative tightening, which will contribute to raising rates at the long end of the yield curve.
Meanwhile, the latest FOMC forecasts for the federal funds rate are 0.90% for 2022 and 1.60% for 2023. Even if inflation starts to recede, and there is no guarantee in this, short-term real interest rates will remain negative throughout 2022 and possibly also in 2023. Real interest rates are current rates minus inflation.
Inflation reduces the purchasing power of money. Central bank liquidity, fiscal stimulus, and pandemic-related supply chain problems over the past two years have accelerated inflation so that it will not be easy to stop it now. The acceleration of inflation is also facilitated by the shortage of labor, due to which wages are rising.
Fintech and Inflation: Cryptocurrencies Offer an Alternative
The fintech revolution has led to increased speed and efficiency in the banking and financial industries. The evolution of fintech includes a new medium of exchange — cryptocurrencies. Governments are famous for their clumsiness. The Fed’s reaction to inflation is an ideal example of a belated reaction to economic processes. People usually vote with their wallet. Faith in governments has weakened over the months that inflation has been rising.
Fintech solves the problem of speed and efficiency. So no one should be surprised by the fact that cryptocurrencies have begun to show sensitivity to inflation. Since governments do not interfere, the value of cryptocurrencies is determined solely by purchases and sales made on the market. And if the government can issue fiat money at its discretion, the supply of cryptocurrencies can only be increased by mining.
While inflation is at its highest levels in 40 years, cryptocurrencies are likely to form a bottom and resume their upward trajectory.
Bitcoin and ether will form the bottom, the bull market is not yet complete
Market rallies rarely have a straight trajectory, and corrections are sometimes merciless. The fall of bitcoin from levels of about $70,000 below $40,000 per token (a recent low) was an example of how a correction can shake the faith of even the most convinced “bulls”.
However, sharp corrections within the bull market do not happen only with cryptocurrencies. Oil futures on the NYMEX fell from a high of $85.41 at the end of October to a low of $62.43 in early December, losing 26.9% in six weeks. Copper futures on COMEX rolled back from a high of $4.8985 per pound in May 2021 to a low of $3.9615 in August, losing 19.1% in three months. Lumber futures fell from a high of $1,711.20 per 1,000 board feet in May 2021 to a low of $488 in August, losing 71.5%.
Commodity prices have recovered from those lows. The same thing, it seems to me, will happen with bitcoin, ether and other cryptocurrencies. Inflation reduces the purchasing power of money, and we measure the value of cryptocurrencies and other assets in dollars. Increased inflation and negative real interest rates are likely to allow cryptocurrencies and many other asset classes to extend a series of higher lows and higher highs.