Bitcoin has been on a tear in 2023 as a confluence of narratives and perceived expiry of risk events have led the talismanic original digital asset to surge more than 82% in under three and a half months and break the psychological $30,000 level. Events in the macro-environment, banking and digital assets sector in the opening months of the year underscore the role of narrative in driving Bitcoin and crypto price action. But, as ever in crypto, all is probably not what it seems.
In the early weeks of the new year, Bitcoin’s price was propelled by receding global macro headwinds after a mild winter supported easing energy prices and prompted a downgrade for inflation, peak interest rates and recession expectations. The subsequent January run-off in inflation caused the dollar to weaken and risk appetite to reignite, sending crypto, along with tech stocks, higher. On 19 January, crypto lender Genesis, part of Barry Silbert’s Digital Currency Group, filed for Chapter 11 bankruptcy protection in the Manhattan federal court in the latest contagion effect caused by the collapse of FTX. Genesis listed more than 100,000 creditors in its bankruptcy filing, with aggregate liabilities ranging from $1.2bn to $11bn dollars, according to reported bankruptcy documents.
As the first quarter wore on, divergence in equity and bond markets became more acute. While equity investors looked past the negative externalities of a higher-for-longer interest rate environment (i.e. demand destruction, lower margins and higher debt servicing costs), which will force asset repricing and increase default and refinancing risk, bond markets signalled a recession was on the way in a historic two- and ten-year US treasury yield curve inversion. In the bull/bear spectrum, crypto investors are even more bullish than equity investors, driven by expiry of peak fear last November following the collapse of crypto trading platform FTX, founded by Sam Bankman-Fried. Some crypto enthusiasts also suspect the Federal Reserve is very close to pausing interest rates – and may even have to cut rates sooner than markets are pricing in. Bitcoin’s price had surged by more than 52% to around $25,300 in the third week of February.
Then, in the second week of March, the breakneck collapse of Silicon Valley Bank (SVB), the specialist technology lender, ignited a rapid deterioration in the operating environment for banks which spread at the same speed as information dissemination. SVB suffered a bank run and collapsed within 48 hours of trying to raise $2.25bn to shore up its balance sheet after reporting steep losses on its bond portfolio, ultimately due to mismanaged interest rate risk. The precise nature of SVB's failure is important, as it triggered a unique response from the Fed, which ignited the original crypto narrative that Bitcoin represented an alternative to the untrustworthy legacy banking system. Ultimately, the wobble in the U.S. regional banking sector sent the Bitcoin price higher in late March.
To briefly recap, SVB invested proceeds from surging pandemic-era deposits – from $61.8bn at the end of 2019 to a peak of $189.2bn at the end of 2021 (2022: $173.1bn) – into high-yielding mortgage-backed securities (MBS), amassing an $80bn portfolio with a 10-year-plus maturity, at the end of last year. However, the Fed’s large and precipitous 450 basis points tightening in the past 12 months eroded the value of the MBS portfolio, creating substantial unrealised losses. US regulations allowed banks not to report unrealised losses in fixed income securities if they were classified as held to maturity (HTM). Unfortunately, as customers increasingly sought access to deposits it created a liquidity problem for SVB which needed to sell high-quality securities at heavy discounts – realising unrealised losses – to reflect interest rate movements since they were acquired. Ultimately, the banking sector was unprepared for the precipitous rise in interest rates, exposing deposit-dependent lenders to a capital flight risk.
In the same week as the SVB failure, Silvergate Capital, which includes MicroStrategy among its clients, announced it would cease operations, and then regulators shut down Signature Bank – both major US crypto banks that had played a significant on-ramp role in bringing institutional capital into the crypto ecosystem. Silvergate and Signature formed a vital fiat/crypto liquidity cog in the digital asset ecosystem; they operated systems used by crypto exchanges to settle transactions in dollars between each other 24/7.
Silvergate Capital shares plunged 33% after the bank reported needing more time to assess the extent of damage to its finances stemming from last year’s crypto rout. The US Federal Deposit Insurance Corporation (FDIC) took control of Signature Bank within days to ensure uninterrupted operation while a buyer was sought. But the admission inflamed fears over whether banks can adequately manage the risks associated with digital assets. SVB and Signature were the second- and third-largest bank failures in US history, eclipsed only by Washington Mutual in 2008.
The failure of all three banks in one week in mid-March removed important capital bridges for the crypto sector which will take time to replace. At the same time, a fresh banking crisis posed risks to the economy reminiscent of the nadir of the 2008 global financial crisis.
But this headwind for crypto was a long-term issue which did not weigh on near-term price action or sentiment. More immediately impactful was the perception among crypto investors that the Fed had introduced a new liquidity wave into the US banking system to stave off dystopian outcomes. The Fed’s aggressive intervention on the evening of Sunday 12 March in the week following SBV’s collapse was designed to protect depositors, not shareholders, and prevent contagion spreading to a run on regional US banks.
The Fed introduced a very generous new lending facility, dubbed the Bank Term Lending Program (BTLP), to provide12-month term loans to banks and other depository institutions which could be secured by collateral valued at par rather than marked to market. Accepting collateral at par rather than marking to market was considered a necessary step to prevent contagion from spreading and creating more bank failures, which served as a clarion call for crypto investors – reviving Bitcoin’s foundational narrative – to disintermediate untrustworthy mainstream banks.
Bitcoin’s price recovered from a retracement to around $19,500 – late 2017’s all-time high price region – and catapulted back higher as crypto investors sensed the Fed’s backstop amounted to “back door QE”, while the evolving banking crisis could even force the Fed, and other central banks, to pivot quickly to cut interest rates. They didn’t. Ultimately, central banks remained hawkish but the narrative supported a rapid move higher – the Bitcoin price surged 37% in under a week to around $28,000, in yet another demonstration of the heightened sensitivity of the Bitcoin price action to narratives rather than outcomes.
In recent weeks, Bitcoin’s price rally has since extended to around $31,000, completing a 100% rally from the lows of $15,500 in the aftermath of FTX’s collapse around mid-November. Annual US CPI data for April came in at 5% March, down from 6% in February, continuing to push the crypto prices across the board higher, further supported by a successful upgrade to the Ethereum network, dubbed the “Shanghai upgrade” as well as indications that FTX may be rebooted as a viable crypto trading platform and exchange after new management has recouped some $7.3bn worth of cash, crypto and other assets. That money will be held until FTX wins final court approval for a creditor payout plan, reports Bloomberg.
By mid-May, after a selectively successful Q2 US earnings season for a handful of influential index U.S. tech stocks, main and crypto markets remained in an overall bullish posture. Bitcoin has remained above $27,000 for the past two months. However, the rally is not built on an influx of new capital but on long-standing crypto enthusiasts who were waiting out the crypto winter in stablecoins and have now moved back into the market after the perceived peak crypto risk has dissipated. This explanation is supported by the Bitcoin dominance chart, which tracks the proportion of all capital in the crypto ecosystem held in Bitcoin. Bitcoin dominance has climbed around nine percentage points at mid-November’s cycle lows to current levels. The question remains whether the crypto Winter is over, and we are now in a crypto Spring, or whether this is a protracted bear market rally which will reverse with main markets for one last sweep of the October 2022 lows, before a sustainable reversal. As ever, there are sufficient market participants which vehemently hold both perspectives to make a market. At the time of publication (10 May), ahead of the latest US CPI data, Bitcoin’s resilience above $27,000 was set to be tested again. Support failure will likely lead to a swift retest of $25,300 level, while a medium0term retest of the $20,000 level over the coming months is anticipated – even by many Bulls who would consider the retrace constructive for a sustainable leg higher in the final quarter of 2023.
Meanwhile, new regulatory frameworks are emerging in Hong Kong, Abu Dhabi and Dubai which are vying to attract the crypto industry to their economies. However, the crypto industry – and prospective institutional investors – are waiting for the SEC and the European Council to finally introduce crypto regulation. Only when regulations are in place is a long-term sustainable recovery realistic in demand for crypto assets. The EU has made more progress to date. In October 2022, the European Council approved the Markets in Crypto-Assets (MiCA) Regulation, one of the first attempts globally to regulate cryptocurrency markets. The regulation extends to money laundering, consumer protection, the accountability of crypto companies and environmental impact.
Ultimately, there are no visible signs yet that the crypto sector has recovered interest from major institutional investors, such as pension funds and insurance companies. Further risk events still have to run off – including absorbing the accumulative impact of the global monetary tightening cycle and the first quarter earnings season which may continue weigh on risk assets heading into the summer. In addition, there are several internal crypto risks including:
- Potential Bitcoin selling pressure due as creditors of Mt. Gox, the crypto exchange which collapsed in March 2014, are set to receive around 142,000 Bitcoins from trustees by 31 October 2023.
- On 27 March, the SEC charged Binance, the world’s largest crypto exchange, and its CEO with violating derivatives trading and registration rules.
- On 22 March, the SEC issues Coinbase, the U.S. publicly listed crypto exchange, with a ‘Wells notice’ related to some portion of the crypto firm’s listed digital assets, staking and custody services. This legal dispute has the potential to be an industry-defining hallmark for the digital assets industry. Coinbase pushed back against the SEC’s legal action. In a public video response, CEO Brian Armstong said: “We are committed to working within the regulatory perimeter we want to see a clear market structure for trading crypto securities. We are going to work with multiple regulators to make this industry safe and trusted and a Wells notice at this stage – when there is not a clear rule book – is not constructive and it's not good for America. We are prepared to defend that position in court, but it doesn't have to come to that. We welcome a true dialogue about workable path forward for our industry.” Coinbase’s full written response was later published on April 19 and can be viewed here.
- On 9 March, crypto exchange KuCoin was sued by the New York Attorney General for operating as an unlicensed broker and alleges Ethereum, the second-largest cryptocurrency, is a security, not a commodity, contradicting the prevailing sentiment among US federal policymakers.
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