Boy, what a difference a year makes…
2021 was a bull market for the ages.
That year, the S&P 500 hit an all-time high of 4,818.62… And bitcoin hit a record peak of nearly $70,000. Everything from meme stocks to altcoins was on fire.
You could literally throw a dart at a stock screen and not miss a big winner.
But as we headed into 2022, stocks and cryptos began their precipitous slide into bear market territory.
So what happened last year?
A major catalyst for the 2020–2021 bull run was easy money. I’m talking about the combination of low interest rates and trillions of dollars in government spending.
Meanwhile, interest rates had hit historic lows.
The combination of trillions of dollars of liquidity entering the economy and historically low interest rates sent asset prices to record highs.
But all that government money printing and historically low rates during the pandemic came at a cost: Inflation.
It hit a 40-year high in 2022.
Inflation soared to as high as 9.1% year-over-year in June. The rate has started to come down since then. It was “only” 7.7% in October.
The need to rein in inflation forced the Federal Reserve to jack up interest rates. And we’ve seen them go up at the fastest pace in history.
For the market, raising interest rates is like forcing an addict to quit cold turkey. It ain’t pretty.
Since the Fed began hiking rates in 2022, we’ve seen the market crash as much as 22%. At the time of writing, the bond market is down 23% – its worst rout since 1926.
Rate hikes hit bitcoin and Ethereum even harder. They’ve been down nearly 75%, respectively, from their peaks.
During times like 2022, it was easy to dismiss the promise of blockchain technology as just another failed trend preying on investors pumped up by a bull market hype machine.
That’s certainly been true for the centralized players in blockchain. I’m talking about now-bankrupt players like Block Fi, Voyager Digital, Genesis, and FTX.
But to confuse the actions of a handful of incompetent (and in some cases) criminal actors with an all-out indictment against the value of blockchain technology is a mistake.
It would be akin to saying you would never buy a stock again because Enron lied about its accounting.
Or saying you would never buy a bond again because the rating agencies lied about the quality of the bonds they gave A ratings to during the Great Financial Crisis.
The issue wasn’t so much the vehicle (stocks, bonds, and crypto) as it has been people who are remarkably good at lying.
The beauty of crypto (when done right) is that you don’t have to rely on trust.
Because of the blockchain’s open nature, you can see exactly who owns what and who is borrowing against their assets.
You can see the value in this approach when you look at where all of the crypto blowups are coming from… centralized players that do not publicly show what they own and how much they are borrowing.
Contrast that against every major decentralized borrowing, trading, and lending protocol such as AAVE, Uniswap, Compound, etc.
And you will see that even in the face of the collapse of 3 Arrows Capital, Luna, FTX, and Block Fi, none of these decentralized protocols have missed a beat.
Because for every single transaction, there is sufficient collateral backing it along with a set of automated risk management rules that will liquidate that collateral the minute certain thresholds are met.
These protocols have no CEOs, boards of directors, risk committees, compliance departments, or so-called “safeguards” that have been in place in every financial firm that went belly up over the last 20 years… in other words, no one to meddle or manipulate.
So, let me stress that the key issue is not more regulation.
Bernie Madoff was in one of the most regulated businesses in the world and still was able to run his $60 billion Ponzi scheme for decades.
So as users of these systems, we must move our transactions to truly decentralized open protocols if we wish to unlock the promise of an open, transparent financial system.
And if we still choose to work with centralized players, we must insist they pull back the curtain and show us blockchain-backed proof of what they own and any liabilities.
Above and beyond the outright theft that tanked crypto prices in 2022, we saw other headwinds that proved too strong for much of the so-called “risk on” sector of the market to overcome.
Inflation and Rising Rates Will be a Wet Blanket
Crypto is the mother of all risk assets. It’s high risk, high reward.
In a low-rate environment, risky assets like cryptos and tech stocks can make you an overnight millionaire.
But when interest rates rise, these assets become incredibly volatile as investors seek out higher-yielding safer investments.
Institutions view cryptocurrencies as high-risk trading assets. That’s why they got so active when money was cheap.
They don’t care about bitcoin’s immutability, its 21 million bitcoin hard cap, or its decentralized design…
Or Ethereum’s ability to become the smart contract platform for any asset today – physical or digital… Or the dozens of other promising crypto projects out there.
They see periods of high volatility and no actual earnings. So they trade it like a speculative tech stock.
In finance, we call these types of investments “risk-on” assets.
Every institution has rules that govern how and when they’ll allocate to them… and they use financial models that change the allocation based on the prevailing interest rates.
The 10-year U.S. Treasury rate – the “risk-free” rate – is typically what they choose.
If that rate of return is higher, they’ll move away from what they see as high-risk investments – things like bitcoin and high-growth tech stocks.
Instead, they’ll move into safe blue-chips with earnings, predictable cash flows, dividends, and inflation protection.
That’s what we saw happen in 2022.
So when the trend turned, and money went from cheap to expensive (like it did last year), what was once a tailwind (cheap money) became a massive headwind as money became more expensive.
As long as the Fed frets about inflation, it’ll keep interest rates high. And that will act like a massive wet blanket over the prices of nearly all risk assets.
Here’s What I Know and What I Don’t Know
I don’t know how long this crypto bear market will last.
But I do know the Fed can’t raise rates forever. Otherwise, it will bankrupt the U.S. government.
The interest payment on U.S. debt is $63 billion per month. At 5%, interest payments would balloon to $127 billion per month, extending the federal deficit by 27%.
So there’s only so much room the Fed has to maneuver before it blows a hole in the federal budget and sinks the entire U.S. economy.
I believe the Fed will cap rates at 6% by mid-2023. Then, it will likely pause rates before eventually lowering them again.
When the Fed pivots from hawkish to dovish, that will remove one of the major headwinds impeding crypto.
The Crypto Story Is Still Alive
I’ve always promised you transparency – in good times and bad.
While 2022 was a year best forgotten, it’s important not to get long-term negative on the space because despite the current Crypto Winter, the future is bright for this asset class.
Every new game-changing trend, whether it was the commercialization of electricity, railroads, automobiles, air travel, or the internet, went through periods of deep investor mistrust, investor booms, and investor panics.
Why should blockchain adoption be any different?
That said, it’s important to stay rational.
That’s why to keep myself from falling into wishful thinking during bear markets like we’re experiencing now, I always review my original bitcoin adoption thesis to ensure we’re I’m not on the “hopium” train.
After all, hope is not a strategy.
Over the years, I’ve told you we’d see bitcoin (and crypto) go from a few hundred thousand users to billions. And in 2022, the adoption story got even stronger.
In September, BlackRock – the world’s largest asset manager with $10 trillion under management – announced it was entering the crypto space.
BlackRock says its institutional clients want access to this space so badly that it’s teamed up with Coinbase to provide them an access point to crypto assets. We’re talking about institutional clients that collectively manage $40 trillion.
For comparison, the entire crypto market is currently around $800 billion. The entire gold market is around $11.5 trillion.
So that’s massive capital waiting to come into the crypto space.
And Fidelity – the retail brokerage powerhouse that more than 35 million people rely on – announced it’ll allow crypto investing in 401(k) plans on its platform.
Having a safe place to buy crypto in tax-advantaged accounts and the entry of real institutional money will ignite the biggest bull market yet.
To be clear: There’s no quick and easy way out of the current bear market. I don’t expect any of the headwinds to clear in less than a year.
But that’s OK.
The headwinds will eventually abate. Sentiment will reverse. And if history is any guide, bitcoin’s price will rally to new all-time highs.
That’s exactly what happened after bitcoin’s 85% implosion in 2018… and after it dropped a stunning 50% in two days during the COVID-19 pandemic in 2020.
For now, 2023 will be a year to accumulate world-class cryptos like bitcoin and Ethereum… high-quality altcoin projects… and tech plays that will be building blocks for a decentralized future… All at a discount.
2022 was a terrible year for tech stocks in general and cryptos in particular.
But in investing, patience is the name of the game.
I want you to look through this down cycle into the next up cycle… because if you have the fortitude to stick through this current Crypto Winter, you’ll come out on the other side even better off than you went in.
Let the Game Come to You!
P.S. In tomorrow’s Daily, I’ll tell you why I’m still bullish on crypto in 2023 – plus two other asset classes I’m eyeing this year.
So stay tuned.