As you surely already know, Bitcoin (BTC-USD) has fallen to less than 1/3 of its maximum value.
The relevant question is whether there will be a recovery, or whether it is the beginning of the end.
Those of us who work in the broader stock market refer to market declines as cyclical, implying that there is some inevitability to an eventual recovery. Crypto providers, whether forex or ancillary services, have adopted similar language, calling the unprecedented crash a downturn, down cycle, or “Crypto Winter.”
After winter inevitably comes spring and summer, and they want to convey that kind of inevitability to crypto recovery.
I postulate that Crypto Extinction would be a more accurate term.
In this article, I intend to use reasoning to show 2 things:
- Why the S&P 500 will always rally (barring extreme circumstances)
- Why We Think The Crypto Slowdown Is Permanent
I think examining why the broader stock market has always recovered from crashes will help illuminate the fragility of the assumption that crypto will have a similar cyclical recovery.
Why the Broader Stock Market Always Recovers
Let’s start with the facts. The stock market has crashed dozens of times in its centuries-old history, but it has always come back to reach new heights.
With each stock market crash, pessimists suggest this time is different. This will be the end of the bull market for XYZ reasons. Either way, these pessimists have proven wrong as the stock market continues to hit new highs in a short time.
There is an underlying mechanism that makes the recovery so reliable and seemingly inevitable: steady US GDP growth.
Individual businesses can and do fail. Even entire sectors can become obsolete, but the economy is an important and diverse mechanism. While some companies are struggling, others are growing. As the overall GDP grows, the market grows and is expected to grow.
As the economy grows, the earning power of the companies that make up the stock market increases, which in turn causes their market prices to rise.
So when investment professionals talk about market downturns as if they were simply cyclical in nature and a recovery is almost inevitable, it’s not hubris. It’s not selling. It is a deep understanding of the sustainability of the underlying economic mechanisms.
Why Crypto Providers Try To Convince You It’s Cyclical
Of course, I cannot know the intention of others. I can only look at the economic incentive. Those who own cryptos have an economic incentive to encourage others to raise prices because it increases the value of their portfolio.
Those who perform crypto-related services have an incentive to say that crypto will recover because when Bitcoin is higher, transaction volume is higher and fee revenue is higher.
Coinbase (COIN) is one such crypto service provider. CEO Brian Armstrong said in an interview on CNBC:
“The downturn is not unusual, as Coinbase has gone through four down cycles in 10 years”
He also said.
“Hopefully it (the downturn) will be 12-18 months with a nice recovery”
It’s pretty much the same as the course when it comes to how crypto insiders describe “slowdown”
Brian Armstrong’s sentiment could be quite genuine. I can’t know his internal thoughts, but I think it’s worth noting that COIN’s business is dependent on a crypto rebound, and so he has more or less no choice but to be bullish publicly.
I disagree with the language used to describe the fall of crypto on 2 points:
- He fails to grasp the magnitude of the carnage
- It assumes it is down for cyclical reasons and will rebound
The crypto crash is far worse than even severe crashes in the wider market. The dotcom bubble burst of 2000, the Great Financial Crisis and COVID were the 3 biggest declines in modern stock market history.
None of them come close to the magnitude of the crypto decline.
Coinbase is the biggest exchange, and it’s down 80%. Bitcoin is the biggest and most stable cryptocurrency, but it is down more than 66% from its highs. Many other parts are already extinct. Many other exchanges and services are declaring bankruptcy.
It’s absolute carnage, but vendors call it a cyclical downdraft.
A cyclical downtrend is what happened to the broader market in the first half of 2022. The major indices were down 10%, 15%, or maybe 20% depending on which index you’re looking at.
It is a cyclic downward current. Crypto 60%-80% down is a disaster.
Why Crypto Bears Aren’t Cyclical
As crypto participants are quick to point out, cryptocurrencies have already gone through down cycles and recovered. So this time shouldn’t be any different, right?
Well, it turns out that previous rallies were the result of expanding the potential investor base via accessibility.
Cryptocurrencies themselves don’t have fundamentals because they don’t produce income or even have a pathway to produce income, but the securities by which people own them do have fundamentals in the form of the Supply and Demand of Securities/Coins.
Any time you increase the pool of buyers for a security, even if only a small percentage of potential new investors end up buying, it has a positive impact on the stock price or, in this case, the room. Bitcoin and other cryptos simultaneously reached peak buyer pool and peak adoption percentage of said buyer pool. This I believe has made last year’s highs the all time high and I don’t think it is plausible to go back to them as this level of hype cannot be replicated.
Perfect storm of hype and access
When bitcoin first started, it was only accessible to the most tech-savvy people and was largely owned by miners. Its meteoric rise in price has been the result of a continuous expansion of the pool of investors via accessibility.
Crypto is now owned by people who until very recently did not even have an investment account. One can trade crypto on their phone with just a few clicks. Accessibility has reached such a ubiquitous point that I don’t see how there wouldn’t be more gains via an increased pool of investors. The hype peaked when billions of dollars were spent by crypto providers, filling a huge percentage of advertising space on the internet, on television, and even on billboards. I don’t think you can spend more ad money in the space than LeBron James advertising crypto in a Superbowl ad.
The hype was not only a product of advertising, but also a dynamic phenomenon. People love to brag, and huge crypto gains have provided an opportunity for bragging. I had a strong feeling that crypto was nearing its peak when I started hearing gym bros talking about their sick Ethereum (ETH-USD) earnings.
Boasting is part of human nature. It is introduced into us in an evolutionary way as a means of increasing social status. I also like to brag, which is why I’m going to tell you that I wrote a short thesis on Shiba Inu when it was more than double today’s price and a short thesis on Coinbase when was almost triple today’s price.
After the crypto crash, however, I believe the hype train is dead. The bragging of crypto gains has been replaced by reluctant admissions from former owners, the same way one would admit to doing stupid things in college.
Perhaps one of the remaining areas for expansion of the investor pool is the involvement of large institutions such as BlackRock. It could indeed be a source of additional demand, but I don’t think it can compensate for all the headwinds of reduced hype.
As such, the mechanism of investor pool expansion that has caused previous rallies in crypto appears to be weak.
I don’t see any replacement mechanism that would lead to a recovery. Unlike the S&P, the crypto has no revenue to back it up. You see, when the S&P goes cheap, earnings yield increases, leading to larger dividends and more capital being retained to further increase those earnings and dividends.
Thus, the good market of the S&P makes investments more and more attractive, thus pulling prices up.
The crypto is not cheap on valuation as it goes down. He has no income to back it up. I see no reason why it shouldn’t just hit zero. While I believe the crypto extinction has begun, I am also fallible, so let’s look at the risks of shorting Bitcoin.
Risks associated with shorting BTC
One of the challenges of shorting in general is that for it to work you not only have to be right, but the way is important. For example, while I’m correct that BTC will eventually drop to zero, if it were to rebound to say $100,000 per coin before that, it could cause significant financial stress and force short sellers to cover.
Thus, to enjoy a short film, one must not only be right about the destination, but also be able to manage the vicissitudes of the path. As such, it can be wise to keep short positions rather small.
This path risk is possibly greater with Bitcoin than it would be with a normal stock because it is a momentum-driven story, which means it can have huge moves on short periods of time.