This is an opinion editorial by Adam Taha, a host of a Bitcoin podcast in Arabic and a contributor at Bitcoin Magazine.
Luna’s infamous collapse was followed by an implosion at Celsius, then suddenly Tron showed hints of demise and now Three Arrows Capital is in deep financial trouble. No one knows who’s next, but one thing is certain: more pain is coming. Current market conditions are revealing capital and technological problems in the cryptocurrency world. Things are not good in the Web3-hood.
What about bitcoin? For the sake of clarity, bitcoin is not crypto. It’s important to distinguish between the two. When I say “crypto,” I'm referring to digital products and innovations that rely on using blockchain technologies to run their projects. As of this writing there are 19,939 cryptocurrency projects out there, most of which appeared in the last 12 months. Why are many of these companies struggling now? How are they failing at a relatively similar time? Are all these projects and companies scams? Did the Federal Reserve cause this? The answer is simply, no. As I said, the market did not cause problems in Web3 and crypto projects, the market simply revealed the rot underneath. The problem is a liquidity problem and not necessarily a technical one. We witnessed a “gold” rush in the most recent market run-up from fall 2020 to spring 2022. That euphoric rush to market meant higher competition. Higher competition created an environment where two things emerged:
- Unrealistic promises: projects promising unsustainable rewards (high yields, foundational upgrades, consensus modifications, etc.) to attract buyers.
- Outright scams: projects with the intent of financial exploitation (scams, false marketing, theft, etc.).
In Luna’s case (which is still under investigation), we saw unrealistic promises. In hindsight, its high-yield promises were a clear red flag. Few people noticed because there was a liquidity party. No project was innocent. Ethereum is still over-promising and under-delivering. As an outsider, I sense that Ethereum’s developers are rushed by venture capitalists and investors to deliver “The Merge.” Many of Ethereum’s users are left jaded with a diminished faith in the network itself.
What made the cryptocurrency market’s soil so fertile for the aforementioned problems? Certainly, there was a level of risk for institutional money, but in a liquid market with near-zero interest rates, it was tolerable. Hence, risk-on mode activated for retail and institutional participants alike. However, when the ride got bumpy and the Fed started changing tone while the stock and housing markets started signaling an increase in risk, risk assets were the first to get sold. Hence, risk-on mode deactivated.
To reiterate, the problem with most cryptocurrencies in general is not a technical problem, it’s a liquidity one. The Fed’s quantitative tightening (QT) announcement in late 2021 threw the market for a spin and the effects were almost immediately clear to all observers. That’s when projects that over-promised and projects with unsustainable yields cracked under liquidity pressures.
What is a liquidity problem? What is quantitative easing and tightening? Quantitative easing is how the U.S. Fed “prints” money into existence. The Fed credits the Fed accounts of sellers of Treasuries and mortgage-backed securities (MBS), and thus expands its own balance sheet in the process. Supporting the market for Treasury debt allows the Treasury to issue more debt, which is serviced by future taxes and has to be paid by future generations. In other words, kicking the can down the road. Since 2008, the Fed balance sheet grew by about $8.5 trillion. Quantitative tightening is when the Fed stops or slows down the purchase of Treasuries and MBS while simultaneously selling these assets in the open market. Since the beginning of June 2022, the Fed has let $45 billion in assets mature without replacement, but their balance sheet only shrank by $23 billion. This is increasingly creating liquidity pressure on the market, and especially for on-risk markets — starting with the cryptocurrency market of course. The Fed wants to fight inflation, and they can do that by raising interest rates and by sucking up liquidity from the market. Until something breaks — most likely the real-estate market.
Up until early 2022, the market was a block party with a gushing fire hydrant openly supplying the market with easy liquidity. That liquidity fire hydrant was unleashed by the Fed itself. Now, the Fed is back to closing that gushing hydrant. Party’s over.
As noted, they will let the cap on current assets on their balance sheet go down by $47.5 billion in assets by the end of this month. Then, they will do the same with another $47.5 billion in July, and another $47.5 billion in August. Then, they will increase that amount to $95 billion starting in September, or so they promised. Remember, the Fed has $8.9 trillion in purchased assets on its balance sheets, so this can take years if uninterrupted by political, financial or other macro factors.
Crypto’s problem is not a technical one, it’s a liquidity one. Surprisingly, the party was happy and going “oh so well” even when scam projects were prevalent and obvious. Evidently, all the market needed was free money, who would’ve known? (Bitcoiners knew.)
Where do we go from here? Jerome Powell announced a 75-basis points hike on June 15, 2022. On the same day, he confessed that U.S. inflation is directly impacted by macro factors that are “out of our control” and that the Fed might change course if inflation showed signs of decline. Other Fed members such as Jim Bullard and Christopher Waller signaled a more hawkish position going forward. However, I believe that more liquidity pain is coming. More pain in the short-to-medium term, and then a pivot in the long term. Party’s back on.
Markets will not recover until the Fed pivots or gets inflation under control in a non-catastrophic way (“soft landing” as Mr. Powell says). Remember that historically, the Fed has always been successful in tackling inflation with interest rate hikes when they reached within 2.5% of the annual inflation rate. Also, note that the Fed has never been able to reach the previous all-time high interest rate since 1982. Why would they succeed now?
What about bitcoin? In times of stress, I always ask myself the following question: Did any of what’s happening change Bitcoin in any way? The answer is always no. So, I buy more. This is the time when generational wealth is created for you, your family and your future. This is the time to buy because the Fed will pivot, the Fed will not create a soft landing, the Fed will impact the dollar and the bond market. The bitcoin supply is still capped at 21,000,000. Bitcoin is still scarce, decentralized, immutable, sound and focused. Crypto is having a reckoning while Bitcoin is doing its thing, the same thing since January 3, 2009.
Each and every token in this most recent bull market relied on easy money from the Fed (liquidity). The current crash is caused by Fed policy and that same Fed policy will change back again — they’ll be back to open that fire hydrant. So, ask yourself: Why invest or support a token or a market that is subject to an unstable Fed policy? While bitcoin is here and is still on point, unphased and unchanged by Fed policy. Of course, those who entered in the last few months don’t believe me, but let this idea marinate in your head: Bitcoin’s price in USD as of this writing ($21,800) is up over 100% since June 20, 2020. That’s a 100%-plus return in just two years. Can the Fed tighten for two years? It certainly can’t.
You and bitcoin will outpace the Fed. So, buy more and happy HODLing.
This is a guest post by Adam Taha. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.