The cryptocurrency market has recently experienced a significant downturn, with the total market capitalization falling by 10% between Aug. 14 and Aug. 23. This decline has brought the market to its lowest point in over two months, standing at $1.04 trillion. The movement in the market has led to a substantial number of liquidations on futures contracts, marking the most significant liquidations since the FTX collapse in November 2022.
The decline in the cryptocurrency market can be attributed to several economic factors. One of these factors is the increase in interest rates, surpassing the 5% mark. As inflation remains above the 2% target, borrowing costs have risen for families and businesses. This rise in costs has put pressure on consumer spending and economic expansion, leaving individuals with less money available for savings. Consequently, many people may be forced to sell their investments in order to cover their monthly bills.
With inflation expectations for 2024 standing at 3.6% and average hourly earnings increasing by 5.5% year-over-year, the Federal Reserve is likely to maintain or even raise interest rates in the coming months. This scenario of high interest rates favors fixed-income investments, which is detrimental to cryptocurrencies.
While inflation has receded from its peak of 9% to the current 3%, the S&P 500 Index remains only 9% below its all-time high. This situation could indicate a “soft landing” orchestrated by the Federal Reserve, suggesting that the likelihood of an extended and profound recession is diminishing. This temporary undermining of Bitcoin’s investment thesis as a hedge creates uncertainty in the market.
Investor expectations were high for the approval of a spot Bitcoin exchange-traded fund (ETF), particularly with endorsements from heavyweight companies like BlackRock and Fidelity. However, these hopes have been dashed as the United States Securities and Exchange Commission (SEC) continues to delay its decision. The SEC cites concerns over insufficient safeguards against manipulation as the reason for the delay. Moreover, a substantial volume of trading occurs on unregulated offshore exchanges using stablecoins, raising questions about the authenticity of market activity.
Financial difficulties within the Digital Currency Group (DCG) have also had a negative impact on the cryptocurrency market. A DCG subsidiary is currently struggling with a debt exceeding $1.2 billion to the Gemini exchange. Additionally, Genesis Global Trading recently declared bankruptcy due to losses stemming from the collapses of Terra and FTX. This precarious situation could lead to forced selling of positions in the Grayscale Bitcoin Trust if DCG fails to meet its obligations.
Regulatory tightening presents another challenge for the cryptocurrency market. The SEC has accused Binance and its CEO, Changpeng “CZ” Zhao, of misleading practices and operating an unregistered exchange. Coinbase also faces regulatory scrutiny and a lawsuit related to the classification of certain cryptocurrencies as securities, highlighting the ambiguity in U.S. securities policy.
Troubles are also arising from lower growth in China. Economists have revised down their growth forecasts for the country, as both imports and exports have experienced declines in recent months. Foreign investment into China dropped by over 80% in the second quarter compared to the previous year. Additionally, unpaid bills from private Chinese developers amount to a staggering $390 billion, posing a significant threat to the Chinese economy.
Investors Turning to the US Dollar
Despite the potential appeal of Bitcoin during a deteriorating global economy due to its scarcity and fixed monetary policy, investors are currently choosing the perceived safety of the U.S. dollars. This preference is evident in the movement of the U.S. Dollar Index (DXY), which has surged from its July 17 low to its current level, marking its highest point in more than two months.
As the cryptocurrency market faces these multifaceted challenges, the ebb and flow of various economic factors and regulatory developments will undeniably continue to shape its trajectory in the months ahead. It is important to question whether the rally in mid-July, from a $1.0 trillion market capitalization to $1.18 trillion, was justified in the first place, instead of focusing solely on what caused the recent 10% correction.