With Bitcoin (BTC-USD) finally achieving the mainstream awareness that its longtime supporters craved, it’s only natural that its most dedicated adherents have remained unphased at BTC’s decline in 2022. Since cryptocurrencies carry a reputation for brutal volatility, Bitcoin is simply doing Bitcoin things. However, prospective investors will need to exercise greater sophistication in their analyses if they wish to navigate the turmoil successfully. Primarily, Bitcoin will become a so-called “show me” asset.
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No longer can investors rely on memes and the power of simply believing that BTC (and other cryptos) will climb. Admittedly, they got away with such naïve reasonings in 2021 precisely because the underlying circumstances (i.e., inflation) bolstered risk-on assets. Still, with the Federal Reserve switching from an accommodative policy to a hawkish one, the paradigm shifted dramatically.
Currently, the central bank aims to unwind prior monetary excesses. Arguably, the COVID-19 pandemic forced federal institutions to take decisive action, flooding the system with liquidity to prevent an implosion. However, with the economy largely stabilizing from the global health crisis, a wild expansion of the money supply was no longer necessary.
Today, holding onto dollars may represent a far more sensible approach than acquiring Bitcoin or any other crypto. That’s because the Fed seeks to have fewer dollars chasing after more goods. Besides, with greenbacks enjoying the backing of the U.S. government as opposed to speculation based on the greater fool theory, BTC suffers from a credibility headwind.
Bitcoin Must Prove Its Independence
Since its invention, Bitcoin has attracted everyone, from market speculators to libertarian philosophers, because of its vanguard approach. Rather than forwarding a new innovation within the same tired financial ecosystem, cryptos – proponents argue – represent an entirely new ecosystem. With this supposed independence, virtual currencies run outside the clutches of existing financial and monetary networks.
In some ways, this narrative rings true. When people conduct banking transactions, the process runs through multiple layers of security and verification protocols. Responsible for such protocols are centralized financial institutions. With Bitcoin (and other cryptos), a decentralized network of public verifiers conducts the aforementioned transactional mechanisms.
In that sense, BTC certainly ranks as independent from the mainstream financial system. Stated differently, if a major banking institution fails, it probably won’t impact Bitcoin’s blockchain architecture. However, transactional independence represents a different framework than the independence of valuation. As the events of last year confirmed, mainstream economic headwinds undoubtedly affect Bitcoin and the virtual currency complex.
When juxtaposing BTC’s price action and the real M2 money stock, the two metrics share a statistically strong, direct correlation. As the money supply increases (inflationary), Bitcoin does as well, and when the money supply decreases (deflationary), the crypto coin follows suit. Therefore, the Bitcoin community doesn’t ultimately adjudicate the underlying asset’s trajectory – the Fed does.
Now, it could be that Bitcoin disassociates from the Fed’s monetary policy as its directional arbiter. Nevertheless, such a dissociation must be proven. Again, investors should let the crypto market show that it’s serious about being a truly independent ecosystem. Otherwise, more hot air could lead to more losses.
A Shocking Credibility Crisis May Impose Lingering Effects
Anyone following Bitcoin to any extent will surely be aware of FTX and its subsequent implosion. Once praised as a genius, FTX founder Sam Bankman-Fried now faces the scorn of the public and serious legal troubles. Despite the obvious reputational damage, some crypto advocates may view this crisis as a long-term positive.
As TipRanks contributor Reuben Jackson stated, FTX and other embarrassing failures allowed the blockchain ecosystem to flush out toxicities. Jackson wrote recently, “the downfall of FTX and Sam Bankman-Fried enabled Binance to position itself at the center of the crypto ecosystem.”
It’s a fair point. However, a main objection to this notion is that the FTX bankruptcy scared off would-be speculators from cryptos altogether. Let’s face reality. FTX wasn’t the first blockchain-related failure, and it might not be the last. Unfortunately, then, the concept of investors losing everything they had because of one person’s recklessness may be a stain too deep to ignore.
As well, with Bitcoin and similar assets rising on the greater fool theory, a cataclysmic scare like the FTX bankruptcy will lead to fewer fools buying cryptos. You might say that FTX provided a much-needed wake-up call. Unfortunately, such a wake-up call probably means cryptos will be deflated for quite some time.
Bitcoin Will Do One of Two Things
At the end of the day, Bitcoin will do one of two things: it will prove worthy of speculation of your hard-earned dollars, or it will not. As an agnostic investor, you must accept whatever answer the market provides and respond accordingly – no more, no less.
