Why is crypto bouncing back?

Blue-chip cryptoassets including bitcoin (BTC) and ether (ETH) have had a very nice 2023 so far, with BTC up roughly 36% since the New Year and ETH up close to 30%. There is growing reason to believe that “the bottom is in” for crypto markets, and some macroeconomic data suggests that this year will be much brighter for the sector than 2022’s 50 cars of fraud and disasters.

That’s probably the most compelling argument for the crypto bottom: that bad actors and the consequences of their contagion have been washed away. Certainly on an emotional level, getting rid of the likes of Alex Mashinsky, Do Kwon, Three Arrows Capital and Sam Bankman-Fried feels like the chance for a fresh start.

This article is taken from The Node, CoinDesk’s daily roundup of the top stories in blockchain and crypto news. You can subscribe to get the whole newsletter here.

The new beginning, crucially, starts from a stronger baseline thanks to the wave of COVID-19 pandemic-driven education and enthusiasm, despite the wave of fraud that closed the last bull. Bitcoin hit a local low of just under $16,000 back on November 9, 2022, which, despite the massive decline from its late-2021 highs, was still up 66% from prices as recently as September 2020.

It’s a lesson well worth learning – cryptoassets continue their decade-plus trend of steady, but volatile, growth. While there are some significant regulatory risks on the table this year, the fundamental trend looks set to continue, minus the peak of 2021’s mania and the influence-hungry grifters who rode it into oblivion.

Still, while getting rid of scammers should mean we’ve removed some major downside risks, it’s hardly grounds for another crypto bull market. Instead, what will matter most over the next year are macroeconomic conditions, particularly the impact of inflation and interest rates on crypto and other risky assets. (Though, as we’ll get into, the dynamic itself can be a primrose road to disappointment.)

The inflation picture is complex worldwide, but the current rally in BTC and ETH seems to reflect a growing sense that America specifically is headed for not just whiplash inflation, but perhaps even a “soft landing” that stops inflation without destroying jobs.

Observers in 2022 seemed to have completely given up on the “transient inflation” thesis that Chairman Jerome Powell and the Federal Reserve tried to sell back in 2021. But in retrospect, inflation has arguably proven to be quite transitory, driven at least as much of the offer. chain and commodity disruptions such as with the basic money supply. US inflation has now fallen for six consecutive months.

The month-on-month figures for December are particularly positive, with the consumer price index (CPI) actually falling by 0.1% on the month. Some household essentials are even below the Fed’s 2% inflation target, with grocery prices rising just 0.2% month over month and gas prices falling 9.4% on the month. It is not enough to erase the steep inflation of the last year plus, but it moves us closer to a new stable baseline.

This has led to widespread expectations that the Fed will soften the agenda for interest rate increases. The four consecutive 0.75% rate hikes in 2022 were historically aggressive, but the market has now fully priced in expectations of a mild 0.25% hike in February, with the chance of no hikes at all in the back half of the year.

It may seem surprising that any increase at all is on the table given that we now have month-on-month deflation, but in fact it highlights another positive data point. The Fed still needs to keep some pressure on simply because jobs numbers remain strong, with the latest report maintaining a historically low unemployment rate of 3.5%, but also some slowdown in wage growth.

It’s almost a Goldilocks-caliber “just right” in macroeconomic terms, presenting the real possibility of a fabled “soft landing” that brings inflation under control without catastrophically stalling the economy and putting workers on the street. In turn, it’s good news for risk-based speculative assets like crypto.

The situation in Europe is more complicated, as former CoinDesker Noelle Acheson examines in the latest edition of her newsletter, Crypto is Macro Now. European manufacturing and services indices for January beat expectations, suggesting the first return to positive economic growth in the zone since June.

But Europe may not be as likely to get a soft landing as the US. The European Central Bank, apparently still worried about inflation, has signaled a continuation of more aggressive rate hikes in the coming months.

There are still far better prospects than in the third major axis of global economic activity, China. The country continues to teeter on the edge of something darker than inflation, or even outright recession. First, although COVID-19 infections have now fallen dramatically since the surprise end of the “Zero-COVID” lockdowns in December, more disruptive waves appear to be on the cards.

Even worse, China still faces an ongoing housing crash that threatens the very foundations of its ever-evolving financial system. After a crackdown on indebted and corrupt developers in 2020, house prices have continued to fall – in fact, the decline accelerated in December. That’s potentially disastrous, because housing makes up a disproportionate 45% of Chinese household wealth compared to a more typical 25% in the United States, according to Federal Reserve data. That means falling house prices are very, very bad for Chinese consumption.

China’s fate is not a particularly direct contributor to crypto markets, given the broad anti-crypto crackdown still in force there. But its outsized impact on the global economy means it has major downstream implications. These impacts could include COVID disruptions severe enough to continue to disrupt Chinese manufacturing, possibly worsening inflation globally. On the other hand, a housing-driven Chinese recession could ease global price pressures – but also drag down global growth and economic enthusiasm.

Having discussed interest rates and price pressures, I feel compelled to point out the problem inherent in that focus. Crypto investors who are mainly concerned about central bank interest rates are implicitly focused on speculative crypto price drivers, including increasing competition for dollars from safe investments like government bonds.

But it may be time to turn away from that mindset. One version of the 2020-2022 story in crypto is that the early pandemic saw legions of new entrants learning about crypto during the 2020 COVID shutdowns, which in turn created a speculative mania in 2021 that then emerged in 2022.

In a perfect world, we would have continued curiosity and real user adoption, without the fads or explosions. These manias, with their expectations of outsized returns, tend to push speculators against charismatic hype men, with their exciting new tokens and promises of outsized returns. 2022 has been a sobering lesson in the extreme risk of following these animal spirits – just ask anyone who held LUNA or FTT this time last year.