Why is Bitcoin Going Down? When Will Crypto Recover Again?

Why is Bitcoin Going Down: Stock Markets, Macroeconomics and the Ukraine War

If you want advanced notice of where the cryptocurrency market is heading, you should really watch the stock market. This claim has received very strong support in the past few months, as falls in the Dow, S&P 500 and NASDAQ prefigured corresponding falls in the cryptocurrency market.

Pretty much every finance-oriented website and news outlet is awash right now with analysts testifying to a loss of investor confidence, with fears of an approaching recession suppressing appetite for riskier assets such as tech stocks. Predictably enough, this includes bitcoin and other cryptocurrencies, with BTC falling by 54% since reaching an all-time high of $69,000 in November 2021.

“It’s a perfect storm for investors with nowhere to hide as Fed hikes, inflation, geopolitical issues, and worries about a recession abound,” Wedbush Securities’ Dan Ives told Fortune. “Tech stocks are getting crushed on this flight to safety, and it’s a bear market mentality with the pain threshold being tested for tech investors.”

Basically, central banks were already likely to tighten monetary conditions, given that extremely liberal quantitative easing — and historically low interest rates — had prefigured a 7% inflation increase in the United States in 2021. In fact, supply chain issues lingering from the Covid-19 pandemic (which is still ongoing) had been a major factor in exacerbating inflation, while the outbreak of war between Ukraine and Russia in February had served as another major catalyst of rising prices (particularly for oil and food).

In other words, everything that could be happening in the world to cause negative investor sentiment is indeed happening. Traders and investors are spooked about the global economy’s prospects and they’re spooked about the increasingly likely possibility of rising interest rates, so they’re selling off riskier assets such as (tech) stocks and cryptocurrencies.

Systemic Cryptocurrency Risks

The thing is, the cryptocurrency market possesses several properties that amplify downside risks during unfavorable economic conditions. So while the NASDAQ has fallen by 25% since the start of the year, the entire cryptocurrency market has fallen by around 34%.

In particular, the cryptocurrency market relies heavily on leverage, meaning borrowing to make trades. This is part of the reason why it can rise so quickly, since a sizable proportion of traders use margin (i.e. borrowed money) to make bigger traders. But conversely, it’s also what can cause it to sink with such frightening rapidity.

The reason why leverage is so dangerous is that borrowing money requires traders to deposit collateral. The amount of collateral required has to increase if the price of the cryptocurrency they bought with borrowed money declines. If this price decreases too much, many traders find they can no longer afford to maintain their position, so their exchange liquidates them.

This is precisely what has been happening in the past few days. In fact, data from Coinglass shows that $1 billion in liquidations took place during the 24 hours to 11:00pm (UTC) on May 10. This is when the price of BTC dipped just below $30,000 (before recovering a little), underlining how a large volume of liquidations can cause a cascade in terms of prices.

Yet the added risk inherent to the cryptocurrency market doesn’t stop there. An overreliance on stablecoins is another major feature of the market, and one particular stablecoin — TerraUSD (TUSD) — appears to have been a big cause of the falls in the days leading up to May 10.

Terra, the platform behind TUSD, had to sell around $1.3 billion of its bitcoin reserves in order to support the price of TUSD, which broke its 1:1 peg with the US dollar and dropped as low as $0.66 early on May 10 (it’s $0.9 as of writing).

Source: Twitter

Needless to say, a forced billion-dollar selloff of BTC doesn’t do much for the cryptocurrency’s price, yet this is all part and parcel of the cryptocurrency market. Indeed, with bitcoin and other cryptocurrencies also potentially used to support the prices of other stablecoins such as Tether, USDC and BUSD (insofar as the cash reserves for these come partly from related crypto-exchanges), the future may hold another stablecoin-induced or -worsened crash.

Lastly, it’s worth remembering that crypto is very much a social media-driven phenomenon. During bad times, this means that fear, uncertainty and doubt spreads very quickly, something which is evident in the fact that “cryptocrash” was trending on Twitter.

When Will Crypto Recover Again?

Now the million-dollar question: when will the cryptocurrency market recover? Given that its current fortunes are heavily bound up with the global economy and stock market, it’s more than reasonable to suggest that things won’t significantly improve until the macroeconomic context becomes more favorable.

Some analysts have painted a very grim picture of the prospects for a quick recovery, with ING Head of Global Macro Research Carsten Brzeski telling CNBC that, because of the Ukraine-Russia war, Europe will see “no return to any sort of normality of any kind right now.”

A recent IMF forecast saw the international financial institution downgrade its global economic forecast for 2022 and 2023. This means that we may not see a real return to normal until next year.

That said, the cryptocurrency sector has at least one development on its horizon that may boost its market. This is Ethereum’s planned move to a proof-of-stake consensus mechanism, something which is penciled in for late summer. The success of this shift could provide the market with just the good news story it’s lacking right now, and will provide investors with renewed faith that the sector is moving in the right direction. But until then, it seems like they will have to endure just a little bit more pain.