Bitcoin And The Tax-Loss Harvesting Rally (BTC-USD)

I have been bearish on Bitcoin (BTC-USD) since my article in October 2021, when I saw the risk of regulation coming among other threats. Investors have cheered the January rally in Bitcoin, but it’s technical in nature and nothing has fundamentally changed in the world’s largest cryptocurrency.

The Bitcoin rally was a brief squeeze for tax losses

Bitcoin’s rally in January surprised the market with a rise from around $16,000 to $24,000. However, further gains may be difficult to achieve as nothing has fundamentally changed for BTC.

Bitcoin started November around the $21,470 level and is now trading at $22,586 with the recent stop suggesting a return to $21-21,500.

The November dump was created by the FTX collapse, while we saw a further decline from December. Many cryptocurrency investors, especially institutions, will have taken advantage of tax losses. Tax loss harvesting is an investment strategy that can be used by investors to limit future tax liabilities by using losses in a current investment year.

In stock markets, tax-loss harvesting comes with the risk of IRS scrutiny as an asset, sold and repurchased within 30 days, can be classified as a “wash trade”. Although there is no formal regulation of crypto, it would be smart to sell before December before pending regulation.

The heavy buying of Bitcoin in early January also created a huge short squeeze, so the rally in Bitcoin is purely technical. If we needed a bell to ring, a Barron’s article predicting a “GameStop moment” in Coinbase (COIN) might be it.

I advised my subscribers to buy Coinbase back on January 11th for a potential 100% rally, and it made a quick 70%, but I told them it was a short-term trade, rather than an investment.

Miners rush to sell BTC as industry consolidates

The Bitcoin mining industry suffered in 2022 as debt-laden miners struggled with the bear market in Bitcoin prices.

The industry has now turned to consolidation as a means of survival with the merger of Hut 8 (HUT) and US Bitcoin announced this week. The move comes after bankruptcies in the mining industry. While some miners were able to pick up new mining rigs and facilities at difficult prices, others such as Austin’s Core Scientific filed for bankruptcy. Greenidge Generation Holdings ( GREE ) has now announced a debt restructuring with its creditors at the end of January, and Pennsylvania’s Stronghold Digital ( SDIG ) did the same this week.

Another aspect of these activities is that companies have used the recent rally to cash in some of their bitcoins to pay operating expenses. Nevada-based, Marathon Digital Holdings (MARA) said last week in its production update that it would sell 1,500 BTC to fund operating costs.

“Marathon may continue to sell a portion of its Bitcoin holdings in future periods to support monthly operations, manage treasury or for general corporate purposes,” the company said.

If the Bitcoin price continues to stall, further mining sales could limit any price gains. Another feature of it is that the rally has helped other downtrodden crypto investment companies that have struggled in the downturn. Forbes magazine estimated in August that 51% of Bitcoin trades are fake, raising further questions about liquidity.

Regulation and other risks continue to weigh on the Bitcoin outlook

The rally in Bitcoin has been technical in nature and nothing supports any real changes in the coin’s outlook. Institutions were afraid to buy into cryptocurrency, and that has only gotten worse with the FTX fallout and the lack of regulation and transparency. There are many risks to the crypto market which includes Binance. I wrote an article on Binance highlighting the risk to the overall market as it is the largest trading exchange with a 24-hour trading volume of $15-20 billion versus the $1.5-2 billion of its closest rival, Coinbase. Binance was not very transparent about its reserves and is constantly under scrutiny with a recent money laundering investigation and the links to the seized exchange Bitzlato.

The real big risk lies in regulation as the market police step up their efforts with a stronger mandate following the collapse of the FTX empire. Bitcoin’s recent price drop is attributed to news that another crypto exchange is coming under SEC scrutiny. The regulator was investigating San Francisco-based exchange Kraken for violations of securities laws, according to reports. It was later reported that Kraken paid $30 million in a settlement and agreed to end its crypto betting operation in the U.S. Rumors are swirling that Coinbase will also be forced to end its efforts, which could add to the recent cutbacks at these companies .

The SEC charged the Gemini and Genesis exchanges with securities violations in January, and that could be the start of a wave of enforcement, after SEC Chairman Gary Gensler previously said that “most” cryptos were securities.

Investors need to look at one important aspect of the SEC’s work. They went after Ripple for slowing the progress of payments, they went after Binance and now Kraken for slowing the growth of exchanges, and they even investigated the creator of the Bored Apes NFT collection. These moves, combined with the accusations against Gemini when the exchange was close to bankruptcy, are a clear sign that the SEC is using power and will continue to do so.

Global regulation is a mechanism that appears to clip the wings of the decentralized newcomers and serve the current players in the financial system. The International Monetary Fund is widely known to want to regulate the industry, and they laid out their ideas after the FTX problems, which I have summarized as follows:

1. “We believe that cryptoasset providers that provide critical functions should be licensed, registered and authorized.” It will require audits of the stock exchanges and improved scrutiny.
2. “The recent FTX failure showed how the combination of exchanges, wallets and market-making services under one group creates significant risks for clients. It is especially important that client funds are separated from other functions.”
3. “Stablecoin issuers should be subject to strict supervisory requirements. We need strong, bank-like regulation for stablecoins, and central banks should take the lead in such an endeavor given stablecoins’ potential presence in the monetary system”. Even more revisions.
4. “There should be clear requirements for regulated financial institutions regarding their exposure to and engagement with crypto”.
5. “Ultimately, we need robust, globally consistent, comprehensive regulatory responses to achieve effective crypto regulation and oversight. The cross-sector and cross-border nature of cryptoassets limits the effectiveness of uncoordinated national approaches”.

In short, bye, bye to a decentralized financial system. Cryptocurrency will simply be a digital version of the current system, overseen by the same institutions.

Finally, in case of contagion, the market may not be over the worst as another BTC slump will turn up the heat on the mining industry and struggling firms like Silvergate Capital, (SI) who could be the next company to go bankrupt, and even threaten his troubled conglomerate, Digital Currency Group.

Large banks are also entering the digital money arena

Although some investors doubt the possibility of central bank currencies (CBDCs) taking off, all major countries are studying the option, with the UK pushing it harder recently.

The Bank of England and the UK Treasury aim to introduce a digital pound by 2025.

Another threat has emerged to decentralized money in the form of a digital payment project that will target the dominance of ApplePay and PayPal. JP Morgan ( JPM ), Bank of America ( BAC ), and Wells Fargo ( WFC ) are among the firms launching a digital payment wallet via their joint venture with Early Warning Services, LLC, which manages their Zelle Payments Network.

The big banks are eyeing the popularity of their digital rivals with PayPal ( PYPL ) having more than 400 million active wallets by 2022, while Apple Pay had over 500 million active users.

It is clear that we are moving towards a digital age of money. However, it still looks unlikely that the global payment system will be decentralized.

Conclusion

Bitcoin investors have cheered a strong rally in January that was largely fueled by tax loss shuffling and a major short squeeze. As the dust settles on retail, the cryptocurrency world is no closer to mass adoption or institutional buying. The arrival of digital payment options from the big Wall Street banks and the fallout from the collapse of decentralized finance and FTX exchanges could mean it’s even further away. Bitcoin is currently a trading vehicle that tracks Fed rate hikes and inflation while reacting to negative sentiment from regulations etc. Investors should treat it as such and not get caught up in the hype.

Editor’s Note: This article covers one or more microcap stocks. Be aware of the risks associated with these stocks.