Dear Bankless Nation,
So…it’s one of those weeks, huh? 📉 Crypto asset prices took a dive
- BTC peaked at $47,900 and fell 15% to a low of $40,700
- ETH peaked at $3,900 and tumbled 20% to a low of $3,120
If you’re one of the many new entrants in this space, perhaps you’re confused, fearful, or even spiraling into confirmation bias, “Ahhh I never should have bought crypto, I knew this would happen!”
To this, I say:
Major market corrections are part and parcel of our fledgling industry. We always joke about being early to crypto, but this is proof. Yes, ETH and BTC are blue-chip crypto assets, but relative to other markets, mature assets don’t fall 15-20% in a week.
Take solace anon, the road ahead stretches far.
But, let’s take a step back. What caused this plunge? Sometimes, market corrections happen when overleveraged whales cause a cascade of liquidations and value gets erased from the market. Other times there’s no apparent cause.
But this time, we can look to off-chain events. Perhaps the most telling was the release of the Federal Reserve’s latest meeting minutes. In the meeting, the Fed signaled their intent to aggressively shrink the US Central Bank’s $8.3T balance sheet in response to rising inflation.
“… given their individual outlooks for the economy, the labor market, and inflation, it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated.” - Meeting Minutes, page 11
Let’s translate: They printed too much money and need to slow down or else the prices of food, groceries, and shelter will continue to rise.
- By March, they’ll stop purchasing government bond
- Somewhere between March and June, they start hiking interest rates
Higher cost of capital 😲
The Fed sets the cost of capital and asset prices to tend to rise when the cost of capital is low. Why park that money you borrowed at 0.01% in a low-yield investment vehicle when you can invest in a risky asset?
Even if your risky asset sees no price appreciation, you can pay back your loan without losing anything except opportunity cost. That’s why asset prices go up in low-interest-rate environments. Risk-on!
But given the right conditions (e.g. fiscal stimulus) all the fresh money entering the economy can bleed into consumer price inflation as we’ve seen recently. This is when voters really notice… and mid-terms are coming!
So the Federal Reserve is increasing interest rates, making it more expensive to borrow new capital. When this happens “risk-on” assets like stocks and crypto tend to fall as a category as market participants rotate money out of volatiles assets and into assets that may be lower yield, but are more stable. After all, they now need to see returns to pay off higher interest rates.
Just see how Bitcoin’s price chart mirrors a NASDAQ composite index:
Summing up: With the Federal Reserve signaling an increased cost to borrow capital, market participants are moving money from high-risk-high-reward assets into low-risk-steady-reward assets.
So what does this mean for you crypto investor?
I think that depends on your character class. What’s your time horizon for crypto?
Are you a tourist, a mercenary, or a settler?
Settlers evaluate the fundamentals. And the fundamentals remain strong: 💪
- Developer activity is at an all-time high
- Ethereum making steady progress towards the Merge
- New users flocking to Web 3
The market environment has changed, but the fundamentals have not.
Don’t panic! WAGMI.
Here’s what’s lined up next:
- A fantastically fun and surprisingly deep conversation with crypto trader Cobie on what it takes to survive in crypto
- How to use StarkEx
- Ethereum Q4 Report (check out our Q3 report!)
Have a 🌈 weekend,
- RSA