The markets are tumbling, and so is your portfolio (and mine), right? Since Terra’s annihilation, a series of events like those of:
- Celsius insolvency issues that made one of the biggest crypto exchanges look like a Ponzi
- The more recent story about 3AC’s insolvency issues, that could become potential dumps for crypto projects such as Avalanche, Bitcoin, Ethereum, etc.
- Tron’s stablecoin depeg
- The presumably short-lived Terra 2.0
All these, among others discussed in the article, have launched the crypto market into a downward death spiral, with $200 million daily liquidations, due to the fact that the crypto market is full of heavily leveraged traders and investors. With regards to bitcoin, it is now considerably below the $20.000 mark, which is a really psychologically negative event, as it is the first time that Bitcoin falls below its past bull run peak. Unknown territory is dreadful for markets.
Inflation and the fears of a global recession are impacting the crypto market
As with any other market right now, the crypto market is suffering from the dire macroeconomic forecasts and news that are everywhere these days and are taking a severe toll across all asset classes. For instance, the S&P 500 index, very representative of the state of the US economy, is down an astonishing 23.39% YTD (year-to-date), being a 20% downfall an official bear market.
The past ten years have been a period of very low-interest rates. This, in simple terms, means that money was ‘cheap’. When I say cheap, I mean that it was fairly inexpensive to go into debt, which incentivized both companies and consumers to spend. This enabled tech companies, who generally need a lot of cash, to scale (a really posh way of saying ‘grow’) their business in hopes of future great profits, while financing their operations by burning humongous amounts of cash on the daily.
Also, due to the COVID pandemic, the Fed and other central banks were forced to print the equivalent, according to TechStartUps, of 80% of the money in existence. In simple terms, the central banks have flooded the economy with more money, which means that the more money there is available, the less value it has per unit. In a nutshell, the dollar, the euro, and other currencies have less value than ever before.
All this money printing, added to the central bank’s QE strategy (Quantitative Easing, which in short terms is the central banks financing the markets by buying stocks and private/government bonds), and added to the supply and demand shocks, the first time both happen simultaneously in history, collapsing the global supply chain, have created what we have all heard thousands of times these past months: inflation and the ‘pop’ of the mother of all bubbles. Inflation is basically the progressive increase of prices of things like:
- Raw materials
Well, basically everything you can buy has increased in price. Inflation is horrible because it drains your buying power; it makes you poorer by the day.
So what are central banks doing to tackle inflation?
Well, two things:
They are increasing interest rates after ending their QE.
This is a topic for a whole article all in itself, so I’ll keep it short. Increasing interest rates makes it more expensive for banks to borrow money. In case you aren’t aware, a retail bank’s business model is to borrow money at a certain interest and lend this same money at a higher interest (for you to buy a car, for instance), keeping the difference. Therefore, the more expensive it is for them, the higher it is for you. On the other hand, by ending QE, they have reduced the capacity of companies and governments to finance themselves, so they need to concentrate on being more rigorous with their spending. The harder and more expensive it is to spend, the less you spend, being this applicable to both people and companies. Bottom line:
What central banks are doing is consciously slowing the economy, so that inflation cools down (prices stop increasing so much).
Short and sweet, markets are falling for fear of these actions by the Fed (the ECB, the European Central Bank, will soon follow with their own dose of rate hikes) will cause a global recession. And, the truth is, it is probably true and we already know that this tighter monetary policy is not even close to ending yet.
Jerome Powell, chairman of the Fed, just announced on Thursday that they will do all that it takes to bring down inflation to 2% — the Fed estimates a 3.4% interest by the end of the year, so there’s plenty of room for other rate hikes over the year .— We’ll see.
Just to be clear, it is not the duty of the Fed to protect your portfolio, as the Fed has two and only two duties:
- Strive for maximum employment (employment is ok as of right now although lay-offs are already beginning)
- Keep inflation low; being the ideal value thought to be around 2%, which is why Jerome Powell is openly seeking that number.
In other words, though they don’t want to crash the market, they will if that brings down inflation. The reason is simple: inflation is the greatest enemy of all because it absolutely erodes families buying power; we have plenty of historical examples:
- Post-WWI Germany (some argue that inflation and consequent poverty were the driving fuel for the rise of the Nazi party and eventually World War II)
- Present-day Venezuela (one of the poorest countries in the world nowadays)
- Present-day Turkey
So, yeah, inflation is bad.
Note: These extreme policies create problems of their own, as purposely slowing the economy generates lay-offs, worsening the other goal of the Fed. Hence, the Fed job is always trying to balance both metrics the best way so that the balance falls out of control, which is exactly the case right now.
Crypto and tech are specifically exposed in this situation due to absurd valuations of cryptocurrencies and tech companies
The crypto market is heavily correlated to tech stocks. This is great in times of economic bonanza, like the past ten years, where economic policies have been very loose, therefore incentivizing consumers to spend and companies, especially Venture Capital firms, to throw money at basically anything with the potential of generating returns.
Some of these tech companies had multibillion valuations with zero profits (actually losing money like hell) and, in some cases, with close to zero revenues. Examples of companies to follow into this category are many, with extremely absurd cases like Rivian, with a $100 billion valuation in their IPO debut in November of 2021, for a company with a revenue of $55 million that same year. For context, Volkswagen was worth $141 billion at that same period, while having revenues of $254.1 billion. In other words, Volkswagen only had approximately 50% more market cap, with 4,618.2 times more revenue. And to this day some people like Cathie Wood, a very famous tech investor, still have the nerve to say that the tech stock market wasn’t in a bubble.
Not surprisingly, Rivian’s stock has fallen a mind-blowing 75% YTD, wiping off $75 billion in value. Similar examples of sheer price destruction are many among tech stocks:
- Shopify, an ecommerce platform leader in their tech segment, is down 76.75% YTD
- UiPath, the RPA Platform leader, is down 58% YTD (75% from ATH)
- Coinbase, the biggest centralized crypto exchange, 80% YTD
- Tesla, still a carmaker but with tech being their biggest selling point (apart from being EV of course), is down 45.8% YTD
- Robinhood, 61% YTD, 80% from ATH
You get the gist. And don’t get me wrong, besides absurd cases like Rivian, some of these companies build great products and are profitable; the problem is that they need so much cash to finance their operations, and cash is just not that accessible any more.
Consequently, being that correlated to tech stocks can’t be that good anymore is it? Unsurprisingly, Bitcoin is down 57% YTD.
Why on earth should I own Bitcoin then?
After this cascade of bad news and negative/please-kill-me-now sentiment I have sweetened your day with, why on earth should you own Bitcoin? Well, in my mind, there are plenty of reasons to:
- The technology. The underlying tech is as sound as it gets: Blockchain is, without a shred of doubt, the future of technology. You can be doubtful of the future value of cryptocurrencies, but the value of blockchain as a fully traceable, top-notch security system, is undeniable, and the use cases for it are in the thousands.
- Decentralization. Bitcoin is, by far and wide, the most decentralized blockchain of them all. Bitcoin has a Nakamoto Coefficient, one of the main metrics to measure blockchain decentralization, of 7,349. For context, the next most decentralized blockchain, Avalanche (I own AVAX tokens) is 26, which is 282 times less. But why is decentralization that relevant? I will post an article that will dive deep into this, but in a nutshell, decentralization is what makes blockchain have an actual value and, maybe even more importantly, it is the core security feature of blockchains. In short, the more decentralized your blockchain is, the harder is to tamper, which is why Bitcoin has never had any downtime (99.98% uptime to be specific as of the 18th of June 2022). The web of the future will be decentralized, and there isn’t any blockchain project more decentralized than the Bitcoin blockchain.
- Risk tolerance. Bitcoin is, taking into consideration the high risk of any crypto investment, the surest bet in the crypto space. Moonboys will argue that ‘Bitcoin is dead’, all why having their mom’s retirement savings in scammy DeFi protocols. It is factually true that Bitcoin has the most investment, both retail and institutional, of them all, and that will continue to be true for the foreseeable future. If you know and understand the tech, sure there are plenty of other cryptocurrencies to invest in, at your own risk and research, but for non-tech people with high risk-aversion, Bitcoin is the surest best, which consequently reduces the risk for all Bitcoin owners. Risk and volatility are important metrics to consider for widespread adoption; crypto markets need to reduce risk and volatility if they want to appeal to a wider audience.
- Web 5.0. Albeit thoroughly described in my article ‘Why is Snoop Dogg talking about Web 6.0’, Jack Dorsey’s new project is essentially the decentralization of the web without using blockchain as the base of all nodes (equivalent to servers in a centralized web), but using Bitcoin as the system that will ensure your identity and data will be protected and self-owned. In short terms, this antagonizing view to Web3 of the future of the decentralized web is a scenario that doesn’t include any sort of cryptocurrencies besides Bitcoin. Please feel free to go into my aforementioned article if you wish (the link is shared below).
- Scalability. The scalability problem of blockchain-based currencies is a known issue, as even Vitalik Buterin, founder of Ethereum, has acknowledged. Presented as the blockchain trilemma, until now, no blockchain project has managed to ensure its blockchain scales without compromising security or centralization. For instance, the most scalable blockchain (when I say scalable I mean that it manages to handle billions of transactions with little cost per transaction, unlike Ethereum), is Solana. However, Solana is painfully centralized, which in my view removes all value to the project. As I said, this is my opinion, not by any means financial advice, as I am no financial advisor and I could be horrendously wrong. And why is this not a problem for Bitcoin? Simple, Bitcoin is not intending to create a cryptocurrency used as a means of exchange like a euro or a dollar. It is limited and time-to-finality is too high to have any utility in a day-to-day exchange currency. Bitcoin’s value is as the means of payment for bitcoin miners that hold the most decentralized blockchain there is, that will eventually be used for many things, none of them being a digital currency.
It is pretty clear now that Bitcoin isn’t valid as a digital currency, but as a store of value because, as of today, like any other blockchain project, hasn’t proved scalability. The question is:
Will blockchains ever scale without compromising security or decentralization?
And you may ask; why is Bitcoin a store of value? Easy. Because it is scarce, and also because it is the valuable digital asset used to incentivize Bitcoin miners to do their work and validate on-chain transactions of the most decentralized blockchain there is. In my honest opinion, and considering I own other cryptocurrencies, the purpose of blockchain could potentially not be that of the platform for digital currencies and the decentralized web, but as a technology that will secure, protect and guarantee data traceability, ownership, and value of digital assets in that future decentralized world. I have not one shred of doubt about the future of blockchain and bitcoin but, as you have read, I do have my concerns about the future of other cryptocurrencies as long as they don’t prove scalability.
A final word
Nothing in this article can be taken as financial advice, for many reasons:
- I am not a financial advisor and I have no clue (nobody does) what the future of blockchain and the crypto market will be
- For your information, I own Bitcoin, Ethereum, Avalanche, and Cardano. Any reference to their project or the underlying cryptocurrency could be potentially biased by the fact I have a financial interest in them increasing in value in the future. Please bear in mind this and do your own research before investing in any of them (or others).
- Crypto is a very risky market, please don’t invest under any circumstances if you don’t understand the technology behind it.