Why is the crypto market down this week?

The cryptocurrency market has experienced a notable downturn recently, with the total market capitalization falling by 10% between Aug. 14 and Aug. 23, reaching its lowest point in over two months at $1.04 trillion. This movement has triggered significant liquidations on futures contracts, the most since the FTX collapse in November 2022. 

Several economic factors have contributed to this decline. As interest rates have surpassed the 5% mark and inflation remains above the 2% target, borrowing costs for both families and businesses have risen, placing pressure on consumer spending and economic expansion. That means less money is available for savings, which could force people to let go of their investments just to cover monthly bills.

Since inflation expectations for 2024 stand at 3.6% and average hourly earnings increased by 5.5% year-over-year, the fastest pace since 2020, the Federal Reserve is likely to maintain or even raise interest rates in the coming months. Consequently, a high interest rate scenario favors fixed-income investments, which is detrimental to cryptocurrencies.

Inflation has receded from its peak of 9% to the current 3%, while the S&P 500 Index is only 9% below its all-time high. This could indicate a “soft landing” orchestrated by the Federal Reserve, suggesting that the likelihood of an extended and profound recession is diminishing, temporarily undermining Bitcoin’s investment thesis as a hedge.

Factors emerging from the cryptocurrency industry

Investor expectations had been high for the approval of a spot Bitcoin exchange-traded fund (ETF), particularly with heavyweight endorsements from BlackRock and Fidelity. However, these hopes were dashed as the United States Securities and Exchange Commission (SEC) continued to delay its decision, citing concerns over insufficient safeguards against manipulation. Complicating matters, a substantial volume of trading continues to occur on unregulated offshore exchanges using stablecoins, raising questions about the authenticity of market activity.

Financial difficulties within the Digital Currency Group (DCG) have also had a negative impact. A subsidiary of DCG is grappling with a debt exceeding $1.2 billion to the Gemini exchange. Additionally, Genesis Global Trading recently declared bankruptcy due to losses stemming from the collapses of Terra and FTX. This precarious situation could lead to forced selling of positions in the Grayscale Bitcoin Trust if DCG fails to meet its obligations.

Further compounding the market’s woes is regulatory tightening. The SEC has leveled a series of charges against Binance and its CEO, Changpeng “CZ” Zhao, alleging misleading practices and the operation of an unregistered exchange. Similarly, Coinbase faces regulatory scrutiny and a lawsuit centered on the classification of certain cryptocurrencies as securities, highlighting the ambiguity in U.S. securities policy.

U.S. dollar strengthening despite global economic slowdown

Signs of trouble stemming from lower growth in China have also emerged. Economists have revised down their growth forecasts for the country, with both imports and exports experiencing declines in recent months. Foreign investment into China dropped by over 80% in the second quarter compared to the previous year. Worryingly, unpaid bills from private Chinese developers amount to a staggering $390 billion, posing a significant threat to the economy.

Despite the prospect of a deteriorating global economy, which could potentially bolster Bitcoin’s appeal due to its scarcity and fixed monetary policy, investors are showing a propensity to flock to the perceived safety of U.S. dollars. This is evident in the movement of the U.S. Dollar Index (DXY), which has surged from its July 17 low of 99.5 to its current level of 103.8, marking its highest point in more than two months.

As the cryptocurrency market navigates through these multifaceted challenges, the ebb and flow of various economic factors and regulatory developments will undoubtedly continue to shape its trajectory in the coming months.

Such a situation could possibly be an outcome of excessive optimism following the submission of multiple spot Bitcoin ETF requests in mid-June, so instead of focusing on what caused the recent 10% correction, one could question whether the rally in mid-July from a $1.0 trillion market capitalization to $1.18 trillion was justified in the first place.