After that, there are fears that bitcoin prices will take longer to recover.
For the past several weeks, bitcoin (BTC) has been hovering around $20,000 after losing more than 60% of its value since its November peak. The recent collapse wiped more than $600 million from its market capitalization and fueled growing fears of a bubble burst.
Negative investor sentiment
Cryptocurrency investors have been on edge since bitcoin fell to around $20,000. Many fear that more unprecedented falls by key players could lead to a further downturn.
Further cuts are likely to increase losses and make it more difficult for the market to recover in the medium term. Therefore, many investors hold back further investments.
Apart from the fall in cryptocurrencies, the liquidation of leading cryptocurrency companies such as Three Arrows Capital (3AC) and the Celsius Network also had a negative impact on investor sentiment.
Singapore-based hedge fund 3AC, for example, dropped about $10 billion in investor funds.
The recent cryptocurrency crash put the company in financial turmoil and prevented it from repaying its creditors and investors.
The Celsius cryptocurrency lending network, which was also revered in cryptocurrency circles, also fell on hard times when the cryptocurrency market collapsed. The company had to stop payments to creditors and customers due to low liquidity.
Such occurrences have shaken investor confidence in the sector and reduced the capital inflow needed to underpin cryptocurrencies such as bitcoin.
Margin calls and liquidations
Liquidation occurs when an asset broker forcibly closes an investor’s secured position due to a loss affecting the initial margin.
Liquidations usually exacerbate market crashes by inadvertently increasing the number of short sales.
On January 11, for example, about $2.7 billion worth of BTC futures contracts were liquidated in the 24-hour period, sending prices down from about $41,000 to less than $32,000.
A similar event took place on June 14 and caused the price of bitcoin to fall by about 15%. Bitcoin worth about $532 million was liquidated as a result.
Although liquidations affect prices in the short term, they also have a negative impact on asset prices by increasing market turbulence, which creates uncertainty. Uncertainty is bad for business because it perpetuates cycles of fear.
Inflation refers to the decline in relative purchasing power using a nation’s base currency. High inflation usually results in higher prices for goods and services and is characterized by fluctuating rates of income. During May, the US consumer price index reached 8.3%. By comparison, it was 0.3% in April 2020, when the COVID-19 lockdown began.
Many analysts theorize that the high inflation rate was caused by the aggressive fiscal policies adopted by the US government in 2020 in response to the COVID-19 pandemic.
The government cut fed interest rates to zero and unleashed a $5 trillion stimulus package to stave off an economic meltdown – far more than the $787 billion used to snuff out the 2008 recession.
Funds used during the pandemic supported the economy and helped stimulate demand for goods and services. However, supply chains have not been able to keep up with the increasing demand for some commodities, leading to higher commodity prices.
Of course, there are other aggravating factors, such as the war in Ukraine, which has affected oil prices and led to higher transport costs.
These elements lead to an increase in the cost of living and a decrease in investment in speculative instruments such as bitcoin due to a decrease in disposable income.
That said, bitcoin prices may recover as soon as the current socio-economic dynamics develop favorably.
Federal Reserve Interest Rates
In March, the US Federal Reserve raised the lending rate for the first time since 2020. At the time, bitcoin prices did not move much as the rate was already priced.
However, the announcement prepared investors for the changes ahead and prompted a gradual decline.
On June 15, the Fed raised its lending rate again, this time by three quarters of a percentage point, the biggest increase in twenty years. This anti-inflationary measure caused the markets to fall in the following days. The Dow Jones was forced to drop more than 700 points, while the S&P 500 fell 3.4%.
Notably, Bitcoin investors began pulling out of the market within days of the announcement, causing prices to drop from $30,000 to $18,900 between June 7th and June 18th.
This reaction was expected because the Fed had already signaled that it was going to raise interest rates. Fed interest rate hikes historically reduce investment in speculative assets like bitcoin.
2021 was a positive year for bitcoin. The cryptocurrency ended the year with about 60% gains. However, this was a nearly 300% increase since the start of the COVID-19 pandemic. Thus, a pullback was almost inevitable due to the overheated market.
Market corrections are frequent and natural, both in the stock market and in the cryptocurrency market. They are usually caused by economic turmoil that prompts investors to withdraw money from the commercial markets.
Major market corrections usually give way to a bear market, especially when there is a sudden drop of more than 20%.
The current cryptocurrency winter is the result of many factors including geopolitical tensions and uncertainty amid reports of a possible recession.
The bitcoin market is likely to recover when these factors are overcome.
What to expect in the near future
Bitcoin should hit a medium-term bottom, allowing the asset to gain some stability, enough to attract investors and encourage bullish sentiment. Speaking to Cointelegraph, Yubo Ruan, Founder and CEO of Parallel Finance – a decentralized finance (DeFi) lending and pledging protocol – said that the market is in a period of transition:
“I think a healthy market has its strengths and weaknesses. The current period is one of consolidation and will gain momentum as many have been on the sidelines waiting for a better price to start buying. Major Fortune 500 institutions and companies are likely to add some level of cryptocurrency to their balance sheets in the coming months. »
Konstantin Boyko-Romanovsky, CEO and founder of the non-hosted hosting and betting platform Allnodes, told Cointelegraph:
“Bear markets and mindsets allow for deep introspection. Now is the time to slow down the race for the next best cryptocurrency and focus on innovation. The blockchains that suffered the most during the latest market crash may need to take a deeper look at what needs to change to remain competitive and profitable in the future. That being said, both the cryptocurrency market and the traditional market will recover. It is a matter of time. »