Why is Bitcoin’s price down?
Bitcoin recently underwent a multi-month decline from $69,000 to just under $33,000. Roughly a 52% decline from it’s all time high price. Why? There are a few possibilities that we will cover but generally the gyrations in price are fairly normal for Bitcoin.
- Russia’s Potential Cryptocurrency Mining Ban
The first possibility for the price drop may have to do with Russia’s Central Bank proposing to ban bitcoin and cryptocurrency mining. As of August 2021, the country holds 11.2% of the Bitcoin hashrate. This is a fairly large portion of the total hashrate, but unlikely the sole reason for the large decline. During the spring of 2021, China had nearly half of all the hash rate. Their ban was partially responsible for Bitcoin’s decline as miners sought refuge in other countries. Russia’s ban has not officially passed yet and is gaining opposition from various tech and government executives who are familiar with the situation.
Source: https://ccaf.io/cbeci/mining_map
- Huobi Exchange Retires Accounts in China
Another possibility for Bitcoin’s recent price drop are the lingering effects of China’s cryptocurrency ban. In September 2021, Huobi Global announced that they would cease operations in mainland China. Their goal was to offboard all accounts by December 31st, 2021. No immediate effect was seen in the Bitcoin price from the announcement but it is possible that many of the Huobi users were selling off their holdings in November and December as the price began to decline.
- Tax-Loss Harvesting
Tax-Loss Harvesting is another possibility that contributed to the price decrease. This method is used by investors and hedge funds to sell off their holdings at a loss in order to offset a capital gains tax liability. If an investor made $100 in capital gains from a short term trade but one of their other positions went down, they have the option to sell the position that went down. They now will not have to pay all or a portion of the taxes on their $100 in capital gains. There are other stipulations attached to doing this but the above example provides the main points of the strategy.
Investors will generally use this strategy at the end of the calendar year but can also be done at any time during the year.
- Federal Open Market Committee (FOMC) Update
The FOMC, otherwise known as the Fed, is a branch within the Federal Reserve that determines the interest rate at which depository institutions (banks) can lend to the Fed and vice versa. The most likely cause for Bitcoin’s decline is the Fed update where they announced a possibility for a change in the interest rates. When interest rates rise (rate hike), consumers and businesses spend less. This causes Hedge funds and retail investors to anticipate a drop in company earnings. They will then usually sell some or all of their holdings in stocks. In addition, risk-on assets usually do not perform well in a rising interest rate environment. Although Bitcoin was designed to act as a store of value, many traditional investors still view it as a risk-on asset and may have decreased their positions with fears of a correction in global markets.
If a drop in the stock market occurs, it affects smaller assets as well. When we compare the size of the stock market to the size of Bitcoin, we see that Bitcoin is significantly smaller. The total size of the U.S. stock market is around $53 trillion while Bitcoin is around $700 billion or 0.14{1b2f824bc6e420fc9a9187b8b3310ed445a6e3af66c80d2539d63fc0a4adee40} of the U.S. stock market’s total market capitalization. It is possible that large holders or institutions may have sold a portion of their bitcoin funds due to the possible rate hikes.
As of right now, the Fed has not officially announced a rate hike but has stated the end of quantitative easing (where the Fed prints and buys assets on the open market) by March. They have also announced the possibility of 3 rate hikes in 2022. Large investors are preparing for that outcome. However, if the Fed does not raise interest rates, there is a possibility that the bitcoin price (along with stock prices) will recover.
How the Inflation Numbers Correlate to Bitcoin
Below we have the M1 money supply as well as the reported CPI numbers. Both have seen an increase around the same time as the COVID pandemic went into effect across the globe. If we compare the recent increases from the charts with Bitcoin’s, one is able to find a correlation between the increase in monetary supply and the rise in Bitcoin’s price. Price action is not usually a one-to-one comparison but the general direction for all of the charts is confirmed.
Source: https://fred.stlouisfed.org/series/M1SL
S&P 500 Price Chart
Bitcoin Price Chart
Source: https://bitbo.io/
Whether or not Bitcoin is truly correlated to inflation, we are able to see the second order effects of the increased money supply. One could also argue that Bitcoin is mainly affected by the macro swings of the stock market. Bitcoin’s correlation to other assets will never occur 100{1b2f824bc6e420fc9a9187b8b3310ed445a6e3af66c80d2539d63fc0a4adee40} of the time but for the majority of Bitcoin’s existence it has followed the stock market. Bitcoin’s swings may experience higher percentages but as more institutions adopt Bitcoin, they will treat it as another part of their diversified portfolio. It is still possible for Bitcoin to eventually become uncorrelated to the overall stock market but it is still too small to be 100{1b2f824bc6e420fc9a9187b8b3310ed445a6e3af66c80d2539d63fc0a4adee40} uncorrelated to larger markets.
Short term macro events will always affect price but in the long term, Bitcoin’s core functions will always provide a store of value for those who wish to opt out of the fiat monetary system.
