Reasons Why Bitcoin is Falling

With high inflation, a downturn in the stock market, and investor fears of a possible recession, this seems like an ideal time to invest in bitcoin. Is there a better time to own a decentralized currency/asset that holds its value?

However, the world’s most well-known cryptocurrency has lost more than 37 percent of its value at one point this year, dropping to nearly 26,000 dollars in mid-May. Just six months ago, bitcoin reached an all-time high of around 69,000 dollars.

By comparison, S&P 500 has fallen about 17 percent since the beginning of 2022. Why has bitcoin recorded such ‘large’ losses in 2022?

A Store of Value?

Risky assets include investments that face a significant amount of volatility in the normal course of the market. Stocks, commodities, and high-yield bonds are considered risky assets, as their prices are expected to fluctuate up and down in almost all market conditions.

Many bitcoin enthusiasts consider the largest cryptocurrency to be a store of value that was somewhat immune to the fluctuations of risky asset values. That is no longer the case. The correlation with traditional markets is at historically high levels. The institutionalization of the crypto market has evidently influenced bitcoin to become increasingly affected by factors impacting the value of risky assets, such as inflation, stock exchanges, and the monetary policy of the Fed.

A Rough Start to 2022

Bitcoin ended 2021 with a gain of nearly 70 percent. This is a fantastic return for any asset class. However, an annual return of 70 percent represents a very mild yield for bitcoin, after it rose more than 300 percent in 2020.

In 2022, investors are in risk–off mode, embracing ‘a general flight to safety in most asset classes,’ said Alex Reffett, co-founder of wealth management firm East Paces Group.

– Investors have shown greater interest in value-based investments and less in speculative stocks and alternative investments in ‘stores of value,’ Reffett added.

One reason is the Fed, which has opted for consecutive interest rate hikes to curb inflation levels not seen in the U.S. for forty years. Analysts expect the central bank to continue tightening rates through 2023.

When the Fed raises interest rates, it affects the demand for products from growing companies, such as tech stocks and risky assets like bitcoin. The question remains how much demand for crypto will persist as liquidity dries up.

– We have no historical precedent for how bitcoin and other cryptocurrencies might react if we enter a sustained period where central banks are actively draining liquidity. These are usually tough times for investors, and risky assets typically perform poorly, said the head of Interactive Brokers Steve Sosnick.

The Most Volatile Asset Class

The equation is further complicated by market disruptions caused by the Russian invasion of Ukraine.

– Geopolitical concerns are driving market instability across many asset classes being traded, and bitcoin has proven somewhat correlated with broad market movements, and less a direct hedge against capital markets, Reffett says.

The problem is that bitcoin has not proven to be a hedge. After all, with inflation at its highest levels in four decades, you would expect a currency that can maintain its purchasing power and be independent of any central bank to gain more followers.

Instead, it seems that bitcoin and the crypto market in general find the most supporters when prices are rising and produce skeptics when the market falls, just like risky assets.

In fact, bitcoin has recorded eight 50 percent declines from its previous all-time high since 2009.

– Anyone who is not prepared for a drop of at least 50 percent should not be in bitcoin. Drops of 50 percent are completely normal for bitcoin. That is the price of admission, said Richard Smith, author of Risk Rituals Newsletter.