Welcome to The Show

Dear Bankless Nation

The 2022 crypto markets have been rough so far.

BTC has fallen below $42,000, bringing almost $1B in liquidations with it.

ETH fell all the way down to $3,000, bringing on its own damage to DeFi markets.

Zooming out on Bitcoin, there’s general consensus among market participants that this chart just looks… weird.

Ether also has this weird unexpected significant drop, after reclaiming new all-time highs, which happened after a blow-off top.

If crypto had died after the blow-off top in May, then no one would be surprised. But instead, we consolidated and resumed the upward, setting new all-time highs and establishing a strong bullish continuation of a broader crypto bull run.

But this trend is facing its death, with a big red candle occurring after 8 weeks of bearish price action. Bitcoin’s famous ‘stock-to-flow’ pricing model is significantly off-track (although many never gave it any legitimacy in the first place).

No one seems to be confident with where we are in the markets. The fog is dense.  The outlook is unclear.

To add further confusion, the equity markets are at all-time highs. Why are the crypto markets acting bearish while the traditional markets set new highs?

What gives?

Macro Inflation

Faster-than-expected inflation has led to a hawkish stance out of the Fed. The Fed must choose between full employment (close) and stable prices (very not close). It seems that the markets seem to be fearful that the Fed is going to target stable prices more than they will full employment, meaning interest rates are going to hike more than expected in an effort to curb inflation.

Last Wednesday, the notes from the Federal Reserve’s December meeting were released. The Fed discussed reducing its balance sheet in order to continue its effort to more aggressively dial back its pandemic-era relaxed monetary policy.

I found Alex Krüger’s thread about the changing stance of the Federal Reserve useful:

tl;dr: It’s not just the rising interest rates, but the rapidly changing stance towards more aggressive balance sheet reduction.

So in less than six months, the Fed went from expecting no rate hikes for 2022 (party goes on) to expecting three rate hikes, accelerated taper, and discussing accelerated balance sheet normalization. Balance sheet normalization was not in anybody's radar for a long time. Not only is this now a possibility in the near term, but also the Fed is talking about doing so faster than in 2018.

That's why crypto assets dropped 15%-30% in two days last week.

The markets always trade on what it believes the Fed will do. And it seems that the market is convinced that the Fed is serious about reducing its balance sheet.

Crypto markets are dependant on capital in-flows. In order for prices to rise, the market needs new capital to flow into the industry. When the central bank goes from funneling in +$120B/Mo into global markets to sucking $80B/Mo out of them, the risk-on assets of the world feel the impact.

It doesn’t matter how bullish some of the fundamentals of this industry are. If the market sentiment is that there aren’t going to be enough inflows to sustain these prices, then people sell.

If people believe that it will cause a price drop, then they sell. And then the prices drop.

Bond Market Movements

Former podcast guest Jim Bianco put a fantastic tweet thread together illustrating the significance of the market pivot that’s occurred over the last week, and it largely falls in line with Alex Krüger’s interpretation too.

Simply put, the bond market saw one of its worst weeks in history because bond market players finally "got it" that the Fed is going to end liquidity. This kicked off a big the scramble to get out and not be the "bond bag holder" when the Fed printer is turned off.

Jim makes an argument that the ATHs of the stock market are not something to feel security in. He claims that the stock market is a lagging indicator of broader market troubles:

So perhaps the stock market is not a place of safety at the moment, however, if we are indeed in for a market downturn, it would be interesting to see crypto markets lead the stock market into a bear market (however short or long that bear market is). Maybe crypto investors are just more on the ball than stock market investors.

If the stock market does indeed turn around from ATHs due the effects covered above, it’s likely not going to be pretty for crypto assets.

The Times Are A-Changin’

I think there’s also a broader change going on in crypto more generally.

Crypto markets are going through a phase-change; a one-time transition between niche speculative degen markets to a global market with significant amounts of responsible capital.

We are going from a market with regular hype cycles, to sustainable, stable, and regular market behavior.

Bitcoin was a household name years ago, but now so are Ethereum, NFTs, and DeFi. The markets are trying to price in new levels of global acceptance, while also more effectively punishing those who are getting too far out in front of their skis and pricing in too much growth too soon.

I believe this transition phase between unstable and volatile markets into more stable and sustainable markets will bring a period of a new type of volatility.

What happens when we put the degens and the hedge funds into the same room? How do hedge funds deal with market volatility and cascading liquidations? How do the degens deal with both strong price floors and ATH sellers?

This new interaction is producing new market behaviors, giving credence to the theory that the typical 4-year crypto cycles are over, and something new is ahead of us.

What that thing is, is yet to be determined.

Living In 2022

The 2020s have so far been a chaotic decade, with no signs of diminishing its uncertain trajectory.

• Why is there such a shortage in labor?
• How will we solve the broken global supply chains?
• How bad is inflation really? Will it get worse or hold steady?
• Is crypto actually getting meaningful adoption, or are we all just JPEG degens?

Markets definitely do not like uncertainty, and this decade has produced more of it.

But fortune favors the bold, and there’s plenty of room in this world for those with long-term conviction to weather any amount of certainty.

So if you’re uncertain, double down on the assets you have the most conviction on. Reduce your leverage, expand your time horizons, and hold.

Because through all this uncertainty, we’re confident of one thing:

Crypto is inevitable.

- David