Crypto's Liquidity Crisis And The Impact To Bitcoin
Kane McGukin | July 22 2022
Bitcoin and other cryptocurrencies have had a tough run since the peak in November 2021. Digital assets are in the midst of a bear market or “crypto winter” that happens to coincide with a global selloff in bonds, gold, stocks (specifically growth), and most other assets. Much of the pressure in cryptocurrencies stems from Bitcoin’s meteoric rise from October 2020 to November 2021. A period where we saw Bitcoin go from $10,000 to a high of $69,000.
During this run, traditional market players like banks, institutions, and hedge funds further adopted digital assets. In doing so, they brought with them a familiar tool – leverage. High valuations in equities coupled with peak pessimism in bonds led to most all assets cooling just as inflation began to rise. This only magnified the unwinding of leverage that occurred in Crypto and bled across the system.
As the daisy-chain of leverage unwound, Terra/Luna, was brought down creating a liquidity crunch for this market segment which sent fears throughout both crypto and traditional financial systems. This event was not too dissimilar from the banking crisis in 2008, leaving no coin unscathed, not even Bitcoin.
Below I’ll make note of a few charts that can help us navigate where we are now, relative to Bitcoin’s historical path.
The Main Question...
Is Bitcoin dead, again?
I don’t think so. Rather, what it seems is that we are seeing a maturation of Bitcoin and the Digital Asset class in general.
Maturity is something that comes with bumps and bruises as we grow.
The S&P, for example, still stands today but has had many crashes over its life.
Amazon, the one we all love today, had the following drawdowns in its first 13 years: -95%, -55%, -66%, -27%. New and innovative technologies are volatile but lead to drastic positive changes over the long run.
The important point: Based on past Bitcoin market cycles, what we are seeing is in line with expectations. It’s likely that we will see Bitcoin and crypto, in general, continue in a bear market for some time. On average, these drawdowns last roughly 315 to 367 days. From November’s peak, Bitcoin’s drawdown was at 227 days (as of the June 23rd post).
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Source: coinmetrics / chart
A chart of monthly active addresses for the Bitcoin network (green) relative to price (red).
This is a good barometer for the growth and use of the network. Much like you may see for Facebook, Instagram, or Twitter when analysts talk about Daily Average Users. User growth supports networks and network effects play a big role in today’s digital economies.
What’s Important: As price moves up you can see address growth. This is showing Bitcoin adoption. Conversely, as Bitcoin's price sells off some users leave. Overall, the user growth now is still above user growth from the last cycle high in 2018. So, over time, the network is still growing and seeing adoption though there is pain present.
Source: coinmetrics / chart
Stablecoins arose out of the last cycle and to put it simply, they act much like money market funds do in traditional markets. They are effectively crypto dollars providing easier access to move from coin to coin or to and from a traditional bank to crypto. These tokens are backed by pools of assets. Some are backed by dollar and dollar reserves (USDC) while others (USDT) are backed by a broader mix of assets that likely contain more risk.
What’s important: Bitcoin and Crypto have matured and are going through mainstream adoption. We’re starting to see investors in these markets behave much like they do in traditional markets. When the market gets turbulent and fear is high, we’re seeing coins sold and moved back to cash like instruments or safety.
The additional attraction for Stablecoins is there is a yield attached to them. In a similar manner to old school, high yield savings accounts, though not without risks. It’s important to understand that nothing is risk free, as with any investment there are risks associated and homework is required to understand when and if it’s right for you.
Yield, many times is a good indicator of risk. Many crypto investors learned this lesson in this cycle.
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In regard to this part of the market, much of the latest news out of the US Government, Bank for international settlements and others has focused on how to regulate, use, and allow these tools to be merged into our daily financial systems along with others like the Bitcoin Lightning Network.
Bank innovation is happening on these digital layers, in Bitcoin, and in other digital coins and tokens. It is a process that will take many years, much like the internet did. It’s still early and we should expect volatility to remain as the markets continue to mature.
For more background and 101 on Bitcoin and Crypto check out our other resources.
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