Bitcoin and Ethereum crashed and recovered before. Will they do it again now?

BITCOIN AND ETHEREUM KEY POINTS:

• Bitcoin and Ethereum have fallen around 75% from their 2021 highs
• While cryptocurrencies have crashed and recovered before, the macro environment is becoming more challenging for risky assets
• Restrictive monetary policy, combined with growing distrust of the crypto industry, may prevent digital tokens from staging a strong comeback in the near term

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Bitcoin (BTC/USD) and Ethereum (ETH/USD) have fallen around 75% from their all-time highs set in November 2021, as speculative appetite has waned considerably against a backdrop of high inflation, rising interest rates, rising recession risks and more crypto-related scandals.

Cryptocurrencies have crashed and recovered before, so it is natural to wonder if the same cycle will repeat itself. For example, both Bitcoin and Ethereum plunged more than 80% from peak to trough in 2018, but then went on to hit new highs over the next 36 months.

Could something similar happen this time? It’s hard to say for sure, but the conditions that spurred the bullish explosion of 2020-2021 have faded. During that period, governments and central banks around the world flooded their economies with liquidity to minimize the damage caused by the health crisis of the coronavirus and to avoid lasting financial scars.

The figure below shows how the money supply in the USA, China, the euro area, Japan and the UK, measured by M2, has increased in recent years. From February 2020 to February 2022, M2 grew by about $20 trillion to $91.45 trillion, more than the previous seven years combined.

MONEY SUPPLY (M2) FOR SELECTED COUNTRIES AND REGIONS

Pandemic-related stimulus led to a voracious speculative frenzy that swept the markets, propping up most assets, including digital tokens. But now the outlook is turning more hostile, with monetary authorities around the world rapidly pulling back housing to fight inflation. The Fed, for example, has raised interest rates by 375 basis points this year, embarking on the most aggressive tightening campaign since the 1980s.

With an increasingly restrictive stance on monetary policy and a tightening fiscal stance from several governments, risk assets will continue to struggle in the short term, but cryptocurrencies will face other headwinds: loss of trust. Recent scandals, such as the FTX debacle, have damaged confidence in the industry, which may take years to restore.

Extreme volatility in the area will also hinder further adoption, as institutional investors will be increasingly reluctant to include cryptocurrencies in their portfolios as a diversification strategy, given their high-risk market structure. Recent price movements have also debunked the idea that these tokens can act as a safe haven in times of market stress.

In the current environment, Bitcoin and Ethereum may remain biased to the downside in the short term. In the longer term, a rebound remains a possibility given the disruptive nature of blockchain technology, but any recovery is likely to be quite slow and non-linear as the era of easy money recedes into the distance.

Click the link below to download Bitcoin’s fundamental and technical outlook for the quarter.

BITCOIN AND ETHEREUM WEEKLY CHART

Bitcoin and Ethereum chart prepared using TradingView

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—Written by Diego Colman, Marketing Strategist for DailyFX