Three words: volatility, volatility, volatility
Impact of the pandemic, geopolitical issues, and rising inflation on crypto
I can’t believe it’s already time for the second Crypto Monkey Blog newsletter.
Over the past week, I got many questions about the volatility we’ve been seeing in the crypto market. Ask and you shall receive, so that is exactly what we’ll cover this week.
If you want to see me discuss specific topics in the future, please reach out. Otherwise, the choice will be left to my whims and desires.
Thank you for tuning in, and see you next Friday!
-Katja
Three words: volatility, volatility, volatility
The pandemic and geopolitical issues have fed into the increasing rate of inflation, contributing to a risk-off economic environment. This bearish sentiment happens during periods perceived as risky and led to the volatility seen in the crypto market over the past two weeks.
Covid-19, the US economy, and crypto
Nationwide lockdowns, increased unemployment, and a widespread sentiment of fear during the pandemic brought the economy to a halt. Although the Federal Reserve managed to keep the US from the worst of the crisis, some lingering effects (supply chain issues and rising energy and oil prices) continue to plague normal business and government operations, increasing the rate of inflation.
At the beginning of the pandemic, many people lost their jobs. No job means no income means decreased demand for goods and services. Without consumers, markets suffer. Therefore, in order to stimulate the economy (bring customers back to spending), the Fed had to implement expansive monetary policy actions that essentially flooded the system with money.
As a first step, the Fed cut the federal funds rate (rate at which banks borrow from each other) to lower short-term interest rates. The Fed also embarked on a large-scale $700 billion quantitative easing program to lower long-term interest rates. To do so, it went into the market and bought securities (both treasury bills and mortgage-backed securities) as well as more risky corporate debt.
In order to make those purchases, the Fed had to print money. In just three months, the Fed printed over $1.2 trillion, which makes up almost 60% of the total M1 money supply today. This is how it flooded the system with money.
By pumping liquidity, the Fed supported the economy and labor markets. Lower interest rates make credit more accessible by lowering the cost of borrowing money. Such “cheap money” bolstered consumer spending and investments by corporations. Although the Fed’s actions helped to avoid the complete downfall of the economy, these initiatives had unintended consequences.
Investors with easy access to additional capital started aggressively investing in all risky asset classes (stocks, real estate, and crypto), which led to the inflation of their prices. Increased wealth from the stock market gains and housing boom also bolstered overall demand for goods and services.
It may sound positive, but in the background of this rising demand, the world was (and still is) experiencing immense supply chain issues. Having more money in circulation at a time when there are fewer goods available creates the perfect circumstances for rising inflation. In the past week, inflation hit 7%: its highest point in the past four decades.
Starting in November 2021, the Fed decided to focus on shifting from stimulating the economy to combating rising inflation. It announced plans for its tapering exercise (i.e. slowing down pumping money into the economy). Also, notes from the Fed minutes (summary from Fed’s December meeting) revealed a projection for three interest rate hikes over the course of this year.
These policies would make money more “expensive” to attain. People will start to save more than they spend. Less money to invest means less demand. Less demand would lead to lower revenues for companies. With lower revenues, companies are less likely to invest in R&D, which slows down economic growth and produces lower company valuations in the stock market.
Such hawkish monetary policy would help explain the crypto market’s recent reaction. Some even argue that the Bitcoin price crash on January 5th happened not because of Kazakhstan’s internet shutdown (discussed later) but because of the statements published by the Fed.
Even though the Fed hasn’t raised the interest rate, the expectation of the increase still has a powerful force over markets. People will sell off their holdings in preparation of the rate hike.
Political turmoil in Kazakhstan and its effect on the crypto market
What started as anger over surging fuel prices turned into a powerful force going after the Kazakh government. Thousands of protestors took to the streets, creating the biggest crisis this country has seen since the 1990s. In an effort to quell the mob, the government has received help from the Russian military and shut off internet access.
[There is much to unpack here, and I would urge everyone to read the news. Since this newsletter focuses on crypto that is what we will discuss.]
When the internet shuts down, miners can no longer communicate with the network, and mining activity ceases. Kazakhstan accounts for almost 20% of the world’s mining power (also known as “hashrate”), second to the US's 35%.
“The shutdown’s impact on crypto mining was evident—the Bitcoin network lost 12 percent of its hashrate. Jaran Mellerud, an analyst at cryptocurrency insights company Arcane Research, estimates that the shutdown alone, which added up to about 100 hours without nation-wide connectivity over six days, might have cost Kazakh miners around $20 million, or $4.8 million for every 24 hours with no internet.” - WIRED
Although the news from Kazakhstan came at a similar time as the news from the Fed, it is hard to ignore the potential effects the geopolitical issue may have had on crypto. This becomes more evident when comparing the situation in Kazakhstan to the Chinese mining ban in 2021.
Such instances typically demonstrate short-term effects on crypto. For example, after the China crypto crackdown, many miners moved to Kazakhstan and North America. Since then, the hashrate has essentially been restored after its significant drop when the news first came. In the long-run, individuals and businesses move to areas that pose less risk to their crypto operation, restoring the crypto market.
Some things to keep in mind
So far, we have covered the ways in which recent events may have had a negative effect on the crypto market. However, the inflation discussed earlier may also have had a positive effect on crypto, especially Bitcoin.
As inflation rises, investors want to put their money into an asset that will preserve its value over time. Bitcoin has the qualities that people look for in a store of value: limited supply (Bitcoin is capped at 21 million) and falling inflation rate (every five years the rate of new Bitcoin entering the market decreases by half). This makes it comparable to a safe haven like gold.
Putting all these ideas together, the pandemic, geopolitical issues, and inflation-hedging nature of crypto could account for the recent fluctuations in the crypto market.
Despite the volatility, institutional and societal adoption continues to accelerate. To illustrate this, here are some crypto news stories just from the past week:
Elon Musk announced Tesla will accept crypto payments for merch
Miami Mayor, Francis Suarez, to accept his full paycheck in Bitcoin and to expand the city’s use of crypto (paying fees and taxes in crypto)
San Diego State University to accept crypto donations (On top of earlier news that top universities like Yale and Harvard are using their endowments to buy crypto)
Arkansas offering $10,000 worth of Bitcoin to incentivize tech professionals and entrepreneurs to relocate to the region
Disney to create its own metaverse
Associated Press to launch its own NFT marketplace for photographers
NBA players Klay Thompson and Andre Iguodala to receive portion of their salary in Bitcoin
Flyfish Club to open the first NFT Dining Club in NYC
Iran to adopt a mechanism for settling international sales with crypto
If nothing else, just remember that market volatility is temporary and crypto is here to stay.