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The Crypto Coaster: What’s Sending Bitcoin on a Wild Ride?
By Scott Bauer, for CME Group
AT A GLANCE
- Though bitcoin ended 2021 up over 62%, the cryptocurrency experienced significant volatility along the way
- The Fed’s handling of inflation and the potential for government regulation are behind some of bitcoin’s recent volatility
From start to finish, 2021 was a volatile year for bitcoin as the cryptocurrency space gained attention and popularity, not only from retail investors, but also from institutional investors and the government. Bitcoin ended the year up over 62%, but it was certainly not smooth sailing to get there; instead, it was more akin to a rollercoaster.
Halfway through April 2021, bitcoin was at all-time highs above $63,000 and had gained over 115% on the year. Just three months later in July, almost all those gains had been wiped out as bitcoin fell back to where it began the year: under $30,000. By early November, bitcoin had returned to its all-time highs above $67,500, before plunging almost 30% in the final two months to finish the year just above $47,000. After falling below $38,000 in February and mid-March, bitcoin is currently back up near $46,000. So, what is causing the volatile swings in the cryptocurrency’s price?
Inflation and the Fed
Following extreme levels of buying over the past two years to support the economy and equity markets, the Federal Reserve (Fed) will begin tapering their purchases of Treasury securities in 2022. With interest rates near zero, the Fed announced at its March meeting the first of multiple rate hikes throughout 2022 designed to try to combat inflation. Volatility tends to occur when the Fed hikes rates off a low interest rate environment. The most significant resistances facing bitcoin and other cryptocurrencies are the actions of the Fed and other central banks across the world and how they try to combat this white-hot inflation.
Inflation has risen to multi-year highs above 7%, and although bitcoin has been viewed as an inflationary hedge over the past several years due to its store of value, it remains a risky asset for investors. As the economy has recovered from COVID-19 at a slower-than-expected pace, this has lengthened the duration of the Fed’s spending and supported the equity markets, and in turn, cryptocurrencies. The Fed’s tapering of Treasury purchases and subsequent rate hikes mean that investors will likely continue the temporarily sell-off of risky assets and begin investing in traditionally safer assets like fixed income.
Not only is the Fed’s battle with inflation affecting cryptocurrency prices, but the threat of government regulation within the digital asset space has worried investors. Although recent events in Russia and Ukraine have interfered with the Biden administration’s attention, they’ve announced that they are working on a framework for how to regulate digital assets. Part of the allure of bitcoin and the blockchain have been their lack of regulation. If the government does follow through with a plan to regulate digital assets, it could deter further cryptocurrency adoption and investment.
Finally, in years prior, investors looked at bitcoin and other cryptocurrencies as alternative investments to the equity markets due to the low correlation between the two asset classes. As bitcoin becomes more widely accepted and adopted, it should become increasingly correlated with stocks and other risky assets. As of writing, the S&P 500 is in a correction, down over 5% in 2022. Although we do not have the same rules and thresholds for cryptocurrencies, bitcoin is experiencing similar day to day volatile swings overall, although it has rebounded since being down over 50% in early January.
Given the current geopolitical conflicts, potential government regulation, and the Fed’s ongoing struggle to safely guide the economy through the COVID-19 recovery – and, in turn, high inflation – volatility in bitcoin should be expected to continue in the coming months. The asset has always been highly volatile and experienced large price swings, and although it is down more than 30% since its all-time highs in November, its long-term prospects remain bullish.