Why Is The Crypto Market Down This Week?

The cryptocurrency market recently experienced a notable downturn, with total market capitalization falling 10% between August 14 and 23, hitting a more than two-month low of $1.04 trillion. The move sparked a massive liquidation of futures contracts, the largest since FTX crashed in November 2022.

Several economic factors contributed to this decline. As interest rates rise above the 5% mark and inflation remains above the 2% target, the cost of borrowing has risen for both individuals and businesses, putting pressure on consumer spending and economic growth. This means there is less money available for savings, which can cause people to give up on their investments just to cover their monthly bills.

With inflation expected to hit 3.6% in 2024 and average hourly wages to rise 5.5% annually, the fastest pace since 2020, the Federal Reserve is likely to keep or even raise interest rates in the coming months. As a result, high interest rates favor fixed income investments, which is bad for cryptocurrencies.

Inflation has fallen from a peak of 9% to the current 3%, while the S&P 500 is just 9% below its all-time high. This could represent a “soft landing” orchestrated by the Federal Reserve, suggesting that the likelihood of a prolonged and deep recession is diminishing, temporarily undermining Bitcoin’s investment appeal as a hedge.

Factors Emerging in the Cryptocurrency Sector

Investor expectations for the introduction of exchange-traded funds (ETFs) have been high, especially backed by heavyweights BlackRock and Fidelity. However, those hopes were dashed as the US Securities and Exchange Commission (SEC) continued to delay its decision, citing concerns about insufficient safeguards against manipulation. To complicate matters, a significant volume of trading still takes place on unregulated offshore exchanges using stablecoins, casting doubt on the authenticity of market activity.

Financial difficulties in the Digital Currency Group (DCG) also had a negative impact. The DCG subsidiary was over $1.2 billion in debt to the Gemini Exchange. In addition, Genesis Global Trading recently filed for bankruptcy due to losses from the failures of Terra and FTX. This uncertainty could lead to a forced sale of positions in the Greyscale Bitcoin Trust if DCG defaults.

Tougher regulation further exacerbates the market's problems. The Securities and Exchange Commission (SEC) has filed a series of allegations against Binance and its CEO, Changpeng "CZ" Zhao, for alleged fraud and running an unregistered exchange. Similarly, Coinbase is facing regulatory scrutiny and litigation over the classification of certain cryptocurrencies as securities, highlighting the ambiguity of US securities policy.

US dollar strengthens despite global economic downturn

There were also signs of problems related to the economic slowdown in China. Economists have downgraded the country's growth forecasts, imports and exports have declined in recent months. In the second quarter, foreign investment in China fell by more than 80% compared to last year. It is alarming that the unpaid bills of Chinese private developers amount to $390 billion, which poses a serious threat to the economy.

Despite the prospect of a worsening global economy that could potentially increase the attractiveness of bitcoin due to its scarcity and tight monetary policy, investors are showing a willingness to focus on the perceived safety of the US dollar. This is evident in the movement of the US dollar index (DXY), which rose from the July 17 low of 99.5 to the current level of 103.8, marking the highest value in more than two months.

As the cryptocurrency market faces many challenges, the ebb and flow of various economic factors and regulatory changes will no doubt continue to determine its course in the coming months.

This situation may be the result of over-optimism after several fictitious Bitcoin ETF bids in mid-June, so instead of focusing on what caused the recent 10% correction, one might wonder if the mid-July market rally was capped in $1000–1180 billion was justified in the first place.