Subsequently, there are fears that Bitcoin prices will take longer to recover.
Bitcoin (BTC) has been hovering around the $20,000 range for several weeks now after the coin lost over 60% of its value from its peak in November. The recent plunge wiped out over $600 million from its market cap and caused rising concerns of a bubble burst.
Negative investor sentiment
Cryptocurrency investors have been on edge since Bitcoin’s fall to around $20,000. Many of them fear that more unprecedented selloffs by key players could precipitate a bigger downtrend.
Further declines are likely to amplify losses and make it harder for the market to recover in the medium term. As such, many investors are holding off additional investments.
Besides the fall of cryptocurrencies, the decimation of linchpin crypto firms such as Three Arrows Capital (3AC) and the Celsius Network has also had a negative effect on investor sentiment.
The Singapore-based 3AC hedge fund, for example, collapsed with about $10 billion in investor funds.
The recent crypto crash threw the agency into financial turmoil and made it hard for it to repay its creditors and investors.
The Celsius crypto lending network, which was also revered in crypto circles, also fell on hard times when the crypto market dropped. The company was forced to halt payments to creditors and customers due to low liquidity.
Such incidences have upset investor confidence in the industry and reduced capital inflows needed to buttress cryptocurrencies such as Bitcoin.
Margin calls and liquidations
Liquidation occurs when an asset broker forcefully closes an investor’s collateralized position due to a loss affecting the initial margin.
Liquidations usually amplify market slumps by inadvertently increasing the number of selloffs.
On Jan. 11, for example, BTC futures contracts worth approximately $2.7 billion were liquidated within 24 hours, causing prices to retrogress from about $41,000 to sub $32,000 levels.
A similar occurrence happened on June 14 and caused Bitcoin prices to plummet by about 15%. About $532 million worth of Bitcoin was liquidated as a result.
While liquidations influence prices in the short term, they negatively impact asset prices by increasing market turbulence, which causes uncertainty. Uncertainty is bad for the business because it extends fear cycles.
Inflation
Inflation refers to the reduction in relative purchasing power using a nation’s base currency. High inflation usually leads to an increase in commodity and service prices and is typically characterized by unchanging income rates. During the month of May, the United States Consumer Price Index reached 8.3%. For comparison, it was 0.3% in April 2020 when COVID-19 lockdowns started.
Many analysts theorize that the high inflation rate was brought on by the aggressive fiscal policies adopted by the U.S. government in 2020 in response to the COVID-19 pandemic.
The government lowered Fed interest rates to zero and unleashed a $5 trillion stimulus program to avert an economic disaster — far more than the $787 billion used to quell the 2008 recession.
The funds used during the pandemic buoyed the economy and helped boost demand for goods and services. However, supply chains were unable to keep up with the growing demand for certain commodities, hence the rise in commodity prices.
Of course, there are other compounding factors, such as the war in Ukraine, which has affected oil prices and led to higher transport costs.
These elements have led to a higher cost of living and reduced investments in speculative instruments such as Bitcoin due to less disposable income.
That said, Bitcoin prices can recover as soon as current socioeconomic dynamics change for the better.
Federal Reserve interest rates
In March, the U.S. Federal Reserve increased the lending rate for the first time since 2020. At the time, Bitcoin prices didn’t move by much because the rate was already factored in.
However, the announcement prepped investors for upcoming changes and touched off a gradual descent.
On June 15, the Fed raised its lending rate again, this time by three-quarters of a percentage point, which is the highest increase in two decades. The anti-inflation measure caused markets to fall in the subsequent days. The Dow Jones was forced to recede by over 700 points while the S&P 500 fell by 3.4%.
Notably, Bitcoin investors began pulling out of the market a few days after the announcement, causing prices to drop from $30,000 levels to $18,900 between June 7 and June 18.
The reaction was expected because the Fed had already signaled that it would be implementing an interest hike. Fed interest hikes historically reduce investments in speculative assets such as Bitcoin.
Market correction
2021 was a positive year for Bitcoin. The cryptocurrency ended the year with approximately 60% in gains. However, this was an almost 300% increase since the onset of the COVID-19 pandemic. Consequently, a pullback was almost inevitable due to the market overheating.
Market corrections happen frequently and are a natural occurrence in both equity and crypto markets. They are usually caused by economic shocks that prompt investors to take money out of mercurial markets.
Major market corrections usually give way to a bear market, especially when there is a sudden drop of more than 20%.
The current crypto winter is the result of a multitude of factors that include geopolitical tensions and uncertainty amid reports of a possible recession.
The Bitcoin market is likely to recover once these aspects are overcome.
What to expect in the near future
Bitcoin is set to bottom out in the medium term, and this will allow the asset to gain some stability, enough to mollify investors and give rise to bullish sentiment. Speaking to Cointelegraph, Yubo Ruan, founder and CEO of Parallel Finance — a decentralized finance (DeFi) lending and staking protocol — said that the market was in a transitional period, stating:
“I think a healthy market has lows and highs. This current period is a moment of consolidation and will gain momentum as many who have been on the sidelines waiting for a better price begin to buy in. Institutions and major Fortune 500 companies are likely to add some level of crypto to their balance sheets in the coming months.”
Konstantin Boyko-Romanovsky, CEO and founder of noncustodial hosting and staking platform Allnodes, told Cointelegraph:
“Bear markets and bear sentiments allow for a thorough introspection. This is a time to slow down the race for the next best crypto and concentrate on innovation. Blockchains that suffered the greatest during the most recent market plunge may have to take a deeper look at what needs to change in order to remain competitive and beneficial in the future. With that being said, the crypto market and the traditional market will recover. It’s a matter of time.”