The price of Bitcoin (BTC) has generally been declining since November, although the cryptocurrency’s sharp price decline this week was likely triggered by rumors on Friday, Jan. 21, related to the U.S. regulation of digital assets.
- Bitcoin’s price on Tuesday, Jan. 25, was nearly 50% below its November high.
- Rumors of a forthcoming U.S. government strategy to regulate digital assets may have triggered the current sell-off.
- Gradual belt-tightening by the U.S. Federal Reserve may also be contributing to Bitcoin’s price drop.
- The price of Bitcoin is likely to be increasingly correlated with the prices of other assets.
Unidentified sources within the Biden administration said last week that the government is developing a strategy to address the economic, regulatory, and national security challenges posed by Bitcoin and other cryptocurrencies. The administration is reportedly also examining the opportunities created by the rise of digital assets, with the Biden administration’s strategy potentially being made public as soon as February.
This likely report from the administration, while welcomed by those who believe that Bitcoin can benefit from greater regulatory certainty, has triggered some traders to sell their Bitcoin holdings. Bitcoin’s price drop from more than $68,000 to current levels just above $37,000 is equivalent to the cryptocurrency losing nearly half its value.
The price of Bitcoin is also being affected by policy changes by the U.S. Federal Reserve. Federal Reserve Chair Jerome Powell said in December last year that the Federal Open Market Committee (FOMC) would double the monthly rate at which it reduces asset purchases. The Federal Reserve is now purchasing $20 billion less of U.S. Treasury securities each month and reducing by $10 billion each month its purchases of U.S. agency securities.
In his post-meeting press conference on Jan. 26, 2022, Powell indicated that the FOMC will adhere to the bond purchase schedule that it announced in December 2021. While the fed funds rate is being kept near zero for now, developments related to inflation may change that. Keeping elevated inflation levels from becoming “entrenched” remains a key focus for the Fed.
Measures enacted by the Fed that are designed to control inflation have had a negative impact on the price of Bitcoin. The values of risky assets—like Bitcoin—tend to decline in the wake of the Federal Reserve making policy changes to become more fiscally conservative.
More broadly, as Bitcoin matures and becomes more widely adopted, the price of Bitcoin is increasingly correlated with the prices of traditional assets like stocks. This growing correlation means that any event that triggers price declines in the traditional markets is likely to trigger similar or greater price declines for Bitcoin.
The one Industrial Average on Tuesday lost more than 800 points before rebounding to post a loss at closing of less than 100 points. Similarly, the S&P 500 lost nearly 3% of its value before rebounding to post a loss of less than 50 points. The Nasdaq Composite Index, which tracks all of the stocks listed on the Nasdaq stock exchange, lost more than 3% of its value at the session low on Tuesday. Several non-U.S. indexes are also experiencing volatility and price declines.
Publicly traded companies with significant exposure to Bitcoin have been experiencing notable price declines. The stock prices on Monday of both Coinbase Global, Inc. (COIN) and MicroStrategy Incorporated (MSTR) declined by more than 15% at their session lows, although prices of both stocks stabilized somewhat on Tuesday. While Coinbase, as a cryptocurrency exchange, has direct operational exposure to Bitcoin, MicroStrategy is an enterprise software company that holds billions of dollars of Bitcoin on its balance sheet.
With inflation high, stock markets sinking and investors apprehensive about the Federal Reserve’s bold new monetary policy stance, you’d think this would be an ideal time to bet on Bitcoin. What better time to own a decentralized currency that holds its value?
Yet the world’s most famous cryptocurrency has lost more than 37% of its value so far this year, falling to almost $26,000 earlier today. Just six months ago, Bitcoin was hitting an all-time high around $69,000.
By way of comparison, the S&P 500 has dropped about 17% since the start of 2022. Why is BTC seeing such steep losses in 2022?
Risk assets are investments that experience a significant amount of volatility in the usual course of the market. Stocks, commodities and high-yield bonds are considered risk assets, because you can expect their prices to move up and down frequently under almost any market conditions.
Until recently, Bitcoin was considered a store of value that was somewhat immune to fluctuations in the value of risk assets. That’s no longer the case. Today, BTC has fallen prey to the sorts of factors that move the value of risk assets—things like inflation, stock markets and Fed monetary policy.
“The reason that this particular decline is occurring right now is because [crpyto] market narratives have shifted from risk-on to risk-off,” author of the Risk Rituals. “Liquidity is drying up as the Fed and other central banks start to taper excess stimulus, and also as regular folks start to realize that Covid-19 is winding down, that we are going to go back to work and that we’re not all buying NFTs and moving into the metaverse tomorrow.”
But there’s another, even more esoteric factor at work in cryptocurrency markets recently, which has helped push Bitcoin even lower.
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