With inflation at an all-time high, stock markets plummeting, and investors wary of the Federal Reserve’s bold new monetary policy stance, you’d think now is the best moment to invest in Bitcoin. What better moment to invest in a decentralized money with long-term value?
Despite this, the world’s most well-known cryptocurrency has lost almost 37% of its value this year, plummeting to around $26,000 earlier today. Bitcoin was at an all-time high above $69,000 only six months ago.
In contrast, the S&P 500 has declined nearly 17% since the beginning of 2022. Why is BTC losing so much value in 2022?
Bitcoin Is Now a High-Risk Investment
Risk assets are investments that have a high level of volatility in the normal course of business. Stocks, commodities, and high-yield bonds are all considered risk assets since their values are likely to fluctuate a lot in practically any market environment.
Until recently, Bitcoin was thought to be a store of wealth that was relatively resistant to risk asset price movements. That isn’t the case now. BTC is now vulnerable to the same kind of variables that affect the value of risk assets, such as inflation, stock markets, and Fed monetary policy.
But there’s another, even more arcane force at work in recent cryptocurrency markets, which has pushed Bitcoin further lower.
Breakdown of Terraform Labs
Terra (LUNA) had a huge outage over the weekend, dropping 90% of its value and wreaking havoc in the cryptosphere.
The Terra protocol’s native token is LUNA. It’s part of the peg mechanism for TerraUSD (UST), the Terra protocol’s other native coin. UST was a pretty popular stablecoin until recently.
The goal of a stablecoin, as the name implies, is to create a “safe” crypto asset with a consistent value. They’re kept in check by tying their worth to the price of a fiat currency like the US dollar. The idea is for the stablecoin to keep the same value as its peg—for example, one coin should always be worth one dollar.
Tether (USDT) and USD Coin (USD) are the most popular stablecoins, and they preserve their pegs by holding substantial amounts of US dollars and other assets to back them up and avoid their value from moving drastically like other cryptocurrencies. UST, on the other hand, is an algorithmic stablecoin that works in combination with LUNA in a completely different way.
The value of UST has dropped by more than 30% this week, calling into doubt the legitimacy of algorithmic stablecoins.
Before the weekend run, it seems that the Luna Foundation Guard was attempting to prop up UST using Bitcoin. The Luna Foundation Guard (LFG), a foundation that promotes the Terra blockchain, purchased $1.5 billion in Bitcoin earlier this month, bringing its total reserves to roughly $3 billion, as part of a bigger ambition to achieve $10 billion in Bitcoin this year.
The LFG said on Monday that it will give out hundreds of millions of dollars in Bitcoin to protect the peg of stablecoin UST.
To 2022, Bitcoin had a rocky start.
Bitcoin increased by about 70% in 2021. For any asset class, that’s a tremendous return. Nonetheless, after increasing more than 300 percent in the lockdown-ravaged year of 2020, a 70 percent yearly return is a bit of a letdown for Bitcoin.
According to Alex Reffett, co-founder of wealth management company East Paces Group, investors are in a risk-off mindset in 2022, embracing “a broad flight to safety across the board in most asset classes.” “Investors have showed a preference for value-based investments over speculative equities and alternative’store of value’ investments as a group.”
One explanation is the Federal Reserve, which has raised interest rates twice in a row to battle inflation levels not seen in the United States in forty years. The central bank is expected to continue tightening rates far beyond 2023, according to analysts.
When the Federal Reserve rises interest rates, it reduces demand for greater growth firms, such as tech stocks, and speculative risk assets, such as Bitcoin. It’s impossible to say how much demand for crypto will exist after all of the liquidity has dried up.
“We have no historical precedence for how Bitcoin and other cryptos will behave if central banks deliberately drain liquidity for an extended period of time,” said Interactive Brokers’ chief analyst Steve Sosnick. “Riskier investments tend to outperform safer ones during these periods of difficulty for investors.”
Bitcoin Has Turned Into a Fickle Beast
Market interruptions caused by Russia’s invasion of Ukraine are also a factor.
“Market volatility in various tradable asset classes is being driven by geopolitical worries, and Bitcoin has shown to be somewhat connected to broad market movements and less of a direct hedge against equities markets,” Reffett said.
The problem is that Bitcoin hasn’t shown to be a very effective hedge against anything. With inflation reaching four-decade highs, you’d think a currency that claims to keep its purchasing value and be independent of any central bank would gain traction. Wouldn’t demand be off the charts if this description applied to Bitcoin?
Instead, Bitcoin tends to attract supporters when the price is increasing and skeptics when sellers are in control—much like a risk asset.
Since 2009, Bitcoin has had eight 50 percent losses from its previous all-time high. “Anyone who isn’t willing to accept a 50% drop should not be investing in Bitcoin,” Dr. Smith added. “Fifty percent drops in Bitcoin are entirely common. It’s included with the ticket price.”
Is Bitcoin a Good Investment?
Buying Bitcoin used to be reserved for tech-savvy early adopters, and a genre of journalism arose to explain to befuddled readers how to exchange dollars for Bitcoin and then swap Bitcoin for something more mundane, such as pizza. (In retrospect, the pizza was overpriced.)
Bitcoin has grown more widespread over time, and it is now easy to purchase via reasonably safe exchanges such as Coinbase. Today, calm, level-headed money managers like those at the Minneapolis-based Leuthold Group argue that a percentage point or two of your portfolio may be allocated to Bitcoin.
By buying Bitcoin now, you’re betting that the speculative excitement will continue, and you’ll be able to sell it for much more than you spent later. However, recent experience suggests that, however intriguing, such ideas are seldom simple to carry through.
You never know when the excitement of speculative investment may go away.