At the time of writing this article, the price of Bitcoin is $36,419.77 according to Coinmarketcap. A huge fall considering Bitcoin reached an all-time high of $69,000 in November of 2021. An almost 50% drop. The whole cryptocurrency ecosystem has been under pressure, with the second-largest crypto, ether, trading below $3000 from the highs of just under $5,000, in 2021.
Other coins across the board are also experiencing a dip in prices.
So why is Bitcoin crashing?
To understand why, first we need to understand some of the factors that can affect the price of Bitcoin and the whole cryptocurrency ecosystem.
- Federal Reserve Interest Rates
While Bitcoin and other coins are of a decentralized nature and are not affected by market forces in the same way as government-backed currencies, they are no longer a standalone risk assets.
Over the years, the rise in Bitcoin has made the world of crypto intertwined with the stock market. Thanks to traditional investors delving into cryptocurrencies. So when the stock market goes down, the same applies to Bitcoin, as evident by the decline in stock prices since the start of 2022.
So how does the Federal Reserve play in this? According to the Bureau of Labor Statistics, inflation in the US rose to 6.8%, the highest since 1982, resulting in the increase of commodities such as food and gas.
To curb the rate of inflation, the Federal Reserve has been mulling an increase in interest rates and plans to stop its stimulus program earlier than planned. Ever since the Federal Reserve December meeting, investors have been expecting interest rate changes, with many responding by selling off riskier assets such as Bitcoin and stocks.
So why do riskier assets suffer when interest rates go up? Interest rates impact a company’s operations as the more the interest rate, the more the cost of capital as a portion of the profits will have to go towards paying the interest rates.
Interest rates also affect the theoretical value of companies, therefore affecting the company’s share value. If interest falls and other factors remain constant, a company’s share value should rise.
Regulations can affect the price of Bitcoin and other cryptocurrencies greatly. The tighter they become, the more likely the price falls. As of today, a total of 9 countries have completely banned the use and mining of Bitcoin and other cryptocurrencies. Others have partially banned crypto by prohibiting financial institutions from associating with crypto. However, many countries still allow the transacting and mining of crypto.
2021 saw one of the biggest crackdowns on cryptocurrencies. In June, China banned all mining and transaction operations of crypto, effectively restricting all decentralized coins. The move saw Bitcoin fall by about 8% and trading at around $41,000.
However, the prices recovered as miners moved to other friendly states like the USA, Kazakhstan, Russia, Iran, etc.
In early January, the plummeting of crypto prices is thought to have been sparked by regulations in Kosovo. The country banned crypto mining after experiencing power outages due to an energy shortage.
In addition, crypto mining operations in Kazakhstan took a hit following an internet shutdown by the government in response to civil unrest, further contributing to the decline in Bitcoin price.
More investors continue to sell as they expect more regulations to affect the cryptocurrency industry. In mid-January, the Russian Central Bank proposed the banning of cryptocurrencies and exchanges amid concerns of risk to consumers and the environment.
The news pushed Bitcoin below the $40,000 mark, considering Russia is home to major mining operations.
On 18th January, the UK Government announced plans to introduce regulations to strengthen the rules on crypto-asset advertisements and protect consumers from misleading claims.
More developments are expected in the crypto regulation space as the Biden Government is expected to release a government-wide cryptocurrency strategy to assess the risks and challenges posed by cryptocurrencies.
Bitcoin’s value is directly affected by its supply. Part of the reason why it’s so valuable and has continued to attract more investors over the years is that it has a limited supply. Satoshi Nakamoto, the creator of Bitcoin, placed a cap of 21 million BTC, meaning no more than 21M will ever exist.
This cap helps to establish BTC as a scarce asset and also control inflation. Roughly every 4 years or every 210,000 blocks, the Bitcoin protocol reduces the reward for mining Bitcoin by half. The process, known as the Bitcoin halving event, makes it less lucrative to mine Bitcoin, requiring miners to look for cheaper electricity and more efficient hardware to get a return on investment.
The halving protects the price of Bitcoin by discouraging miners from introducing more Bitcoins to the network, especially when prices are falling.
Out of the total 21 million BTC, about 19 million have already been mined. However, as the halving continues, it is expected that the last of the Bitcoins will be mined in 2140. You can expect the Bitcoin price to increase every time a halving occurs as it means the supply is reducing.
Bitcoin has experienced a surge in demand over the past few years. Traditional investors have joined in for fear of missing out, and governments like El Salvador have designated Bitcoin as legal tender. Attention by the media and influencers has also helped in convincing many to join the world of crypto, thus opening more liquidity taps.
In addition, developments like NFTs have brought more liquidity to the market.
How does demand affect the price of Bitcoin? More buyers than sellers mean the price of Bitcoin will go up. However, right now, as cryptocurrency prices are tumbling, demand is low as the sellers are more than the buyers. A huge sell-off is happening, with many liquidating their riskier assets due to the points mentioned above, including regulations and interest rates.
The decline has been exacerbated as new and short-term investors continue the sell-off, especially those who bought during the highs, according to Marketwatch.
While wall street may be responsible for a substantial portion of the sell-offs, according to the Wall Street Journal, retail investors seem to be responsible for furthering the drop in crypto prices, as evident by the decline in small transactions by 40%, between the first quarters and fourth quarters of 2021.
Will Bitcoin Crash Again in 2022?
It’s hard to predict the price of Bitcoin due to several factors affecting the market. However, you can expect to have a clearer picture of the market once the federal interest rates have been adjusted and the Biden administration outlines its plans for crypto regulation.
Bitcoin is a volatile asset, however, you can be sure the price will go up again. This is not the first crash to happen. In mid-July of 2021, Bitcoin fell below the $30,000 mark before experiencing a bullish rise to just over $40,000 by the end of that month.
Also, considering that as the halving process continues, the price will likely go up as scarcity increases.
Going by Bitcoin’s price history, this seems to be the best time to add more to your portfolio. As a long-time investor, the best time to buy is during the dip. You don’t want to purchase during the highs as you’ll be tempted to liquidate during a crash.
Experts also recommend diversifying your portfolio, don’t put all your money in crypto. That way, you won’t lose everything during crashes like this. Apart from the likes of Bitcoin and Ethereum, you can diversify your portfolio with stable coins such as Tether, stocks, bonds, etc.
Lastly, a word of advice is to invest in crypto what you can afford to lose as crypto is a very volatile market.
Written by Edmond K.