There is a lot of bad news incorporated into the cryptocurrency market. The largest and most liquid cryptocurrency, Bitcoin, dropped 64% in 2022 (see chart). The decline in cryptocurrency exchange rates declined for several reasons. Riskier assets came under pressure in 2022 as digital currencies, equities, and commodities declined. The U.S. benchmark technology Nasdaq dropped about 33% year to date. One asset that experienced positive returns in 2022 was the U.S. dollar, and the rise in the greenback was one of the reasons cryptocurrencies experienced negative returns. The dollar index, a basket of currencies versus the U.S. dollar, rose slightly more than 8% year to date in 2022.
As investors look forward to 2023, many of the same factors that eroded the value of cryptocurrencies will continue to impact cryptocurrencies initially in 2023. Central banks around the globe are expected to continue to raise lending rates. Equity markets will remain under pressure. Investor confidence will need to recover in the wake of the FTX collapse, and the Winklevoss twins and their crypto exchange Gemini sued for Fraud over interest accounts.
Higher U.S. Interest Rates impact a Strong Dollar
The U.S. dollar heavily impacted the decline in cryptocurrency exchange rates in 2022. Cryptocurrencies trade as an exchange rate. For example, on December 30, 2022, the bitcoin exchange rate to the U.S. dollar was about 16,500 bitcoin to the U.S. dollar. They are valued versus each other and other fiat currencies such as the dollar, the Euro, and the Yen. The dollar’s strength, which grew more than 8% year to date, put downward pressure on other fiat currencies and cryptocurrencies.
The strength in the dollar came as investors looked for a haven to park their money during turbulent times. It was also a beneficiary of rising U.S. interest rates relative to other fiat currencies and cryptocurrencies. Currencies such as the greenback benefit as U.S. interest rates rise, making holding that currency more attractive. The Federal Reserve increased interest rates by about 4% in 2022, including three consecutive 75-basis point interest rate hikes in May, June, and September.
The Federal Reserve is expected to continue to raise rates in 2023. The ECB is also likely to continue to increase interest rates in 2023 to battle rising inflation expectations. The initial uncertainty of higher rates will likely keep riskier assets like cryptocurrencies capped until it is clear that interest rates reach a neutral level.
The question for investors is when will central bank is likely to stop raising borrowing rates, which will help cryptocurrencies form a bottom. According to the CME Fed Watch Tool, which tracks the market’s view of when interest rates will rise, the Federal Reserve expects to continue raising borrowing rates by another 75 basis points until May of 2023. Expectations are for the Fed to stop increasing funding rates at 5%. The 5% level appears to be the terminal rate where interest rates stop rising. At this level, interest rates are likely to be above the core personal consumption expenditure inflation gauge that the Fed watches and could be where the Federal Reserve starts to pivot. There is a lot of uncertainty with global economic growth. Growth could come under pressure as higher interest rates reduce job growth and eventually lead to less spending. The goal of lower growth and declining spending is geared toward lowering inflation.
Sentiment Remains Negative
Even once central banks around the globe move to a neutral trading policy, sentiment toward cryptocurrencies needs to turn positive. The current state in the wake of the FTX bankruptcy and the recent fraud accusations regarding Gemini continues to weigh on the industry.
The FTX bankruptcy and subsequent trial of its CEO will lead to a period where some investors will attempt to recoup their losses. Billions of dollars in losses were transferred from Alameda Research, the hedge fund Sam Bankman-Fried ran, to other traders, and it will take time to see if any funds can be recouped.
Gemini Trust and its founders, the Winklevoss twins Tyler and Cameron, were sued by investors who contend that the crypto asset exchange sold interest-bearing accounts that did not register as securities.
Investors who use the Gemini exchange accused in a class action suit that the founders of Gemini violated the exchange act. Gemini’s products attracted investors with claims that they would earn 8% annually. In November 2022, the company started halting redemptions in the wake of the FTX blowup. With multiple exchanges having regulatory issues, investor sentiment remains negative.
What Will Generate Positive Sentiment
Despite the negative sentiment, blockchain acceptance is rising. For example, the gaming industry is accepting cryptocurrency through bitcoin trading, reducing the need for intermediaries and cutting down the use of credit and debit cards. Players in the gaming space are earning cryptocurrency rewards thanks to the rise of blockchain technologies. Additionally, more financial institutions are beginning to accept cryptocurrency and blockchain technologies.
What Should Investors Look For?
The bottom in cryptocurrency will likely coincide with the base in other riskier assets such as stocks. Nobody has a crystal ball to determine the right time to purchase cryptocurrency, but the market is likely closer to the bottom than the top.
If you believe in the saying “don’t fight the Fed,” then you want to wait until the Federal Reserve stops raising interest rates before you begin to take a position in cryptocurrencies. Unfortunately, if you wait until the Fed starts to reduce interest rates, you will likely miss the beginning of the trend. Some investors might be waiting for inflation expectations to turn around. The U.S. Federal Reserve uses the core personal consumption expenditures gauge. While this gauge is still near its all-time highs, many subindices, such as rent, are starting to turn lower. When the markets believe central banks are near their terminal rate, a neutral policy should exist. If the contraction in growth generates lower inflation and restrictive policy unfolds, the Fed should turn to an accommodative policy which should help buoy riskier assets, including cryptocurrencies.
The Bottom Line
What appears clear is that the exchange rates of cryptocurrencies are in a downtrend, which generated negative returns throughout 2022. There were several driving factors, but the main issues were higher global borrowing rates and the undermining of sentiment in cryptocurrency.
The Fed was the most aggressive of the central banks regarding the acceleration in rate hikes. While the U.S. Central Bank started slowly, it quickly picked up speed to notch up a 4% increase in the borrowing rate. The Federal Reserve controls the Fed Funds rate, the target rate banks use to lend to one another. While the Fed does not control the cost of borrowing beyond the interbank market, the impact bleeds into all lending aspects, including home loans, car loans, and credit card loans. As rates become more restrictive, the consumer pulls back, and riskier assets like stocks and cryptocurrency experience headwinds.
Sentiment in the cryptocurrency space has also become toxic. The FTX bankruptcy describes the height of greed, which eventually led to the undermining of one of the most prolific exchanges in the world. The massive volumes of transactions and immense dollars spent on advertising lift the exchange to superstar status. The profile of FTX was not enough for the company owner, who also wanted to control the industry and speculate on the cryptocurrency markets using customer funds. Some will feel the blowup of FTX for years. Cryptocurrency billionaires and millionaires might have had their capital stolen and lost. If its returns, it will take years.
For example, in the wake of the Madoff scandal, which lost $65 billion in capital, relief is still underway ten years after a fund was established. The Madoff relief fund was created in 2013. The fund is used to distribute funds forfeited to the United States to victims of the Madoff fraud. Since its inception, the U.S. Department of Justice has approved 42,719 claims from Madoff victims.
The Madoff fraud started to rear its ugly head in 2008. Nearly 15 years later, victims of the Fraud still receive portions of the money they lost. The FTX potential fraud could be just as large and take just as long to recover customer funds.
It will take time for investors to regain confidence in cryptocurrency and the exchange rates reflect this fact. When interest rates start to decline, and the exchange rate starts to rally, investors will move on from the pain of losing money through FTX or another exchange that had issues and has generated a sour taste for some investors.
|Disclaimer: This is a guest post. Coinpedia does not endorse or is responsible for any content, accuracy, quality, advertising, products, or other materials on this page. Readers should do their own research before taking any actions related to the company.|