Bitcoin crash - opportunity or trap?

Cryptocurrencies are an increasingly important asset class that has grown strongly in popularity over the past several months. Concerns about inflation or the still significant actions of central banks have contributed to the search for alternative ways to secure the value of one's portfolios. Cryptocurrencies and in particular Bitcoin are still a novelty for most of us and its high volatility can still be a deterrent. Especially when we see such drastic declines as we saw during the past first weekend of December. Are such huge moves the capitulation of the bulls? Or is it just a temporary stop before the markets go up again?

From zero to hero

The outbreak of the pandemic caused investors to seek liquidity virtually everywhere. Even Bitcoin, which was supposed to be an alternative to all other means of investment, started to scrub the bottom at some point. The price dropped to the $4,000 level in March 2020 and it seemed that this might be the end for the crypto market for a long while. However, the situation turned out to be quite the opposite. Bitcoin became a hedge against the "money helicopter", from which gigantic amounts of cash were dropped by governments and central banks around the world. The price scored a massive, almost 1500% rise to $65,000 in about 12 months. Regulations in China shook the market but only for a moment. After a more than 50% correction, Bitcoin became an investor favourite again and reached almost $70,000 in November this year.

Behind Bitcoin's rise is not only inflationary uncertainty, but also the growing acceptance of the new technology. More than 18,000 companies already accept crypto payments and the number of users of digital assets is estimated at around 300 million. It is also worth mentioning the increasing availability of cryptocurrencies to a diverse range of investors. The entry of ETFs or futures funds has led to the fact that now almost everyone is able to invest in cryptocurrencies, with a far greater degree of security than is the case with direct investment.

Another blow to the crypto market

Because the global financial market is increasingly involved in the cryptocurrency market, bitcoin or other altcoins are reacting to changing conditions. A strong dollar, expectations of interest rate hikes or coronavirus all have an impact on limiting the upside potential of cryptocurrencies. Despite Bitcoin's growing popularity, it is not uncommon to see some really big moves. This was the case during the first weekend of December, when Bitcoin found itself as much as $15,000 lower over two sessions. On Saturday morning, the value of Bitcoin fell by 20% within an hour, which certainly scared all cryptocurrency holders. What was the cause of the drop?

Traders involved in contract trading, not only from the institutional side, decided to close a large number of their positions. The value of contracts fell on Friday from $23 billion to $16.5 billion, the lowest since early October. The liquidation of so many contracts led to the cryptocurrency market capitalization falling by more than $500 billion at one point. Of course, one may ask why investors decided to take such a step? First of all, there is talk of fear of a similar capitulation as at the beginning of the pandemic, although on the other hand, there is suspicion that behind the liquidation of contracts are large investors in the cryptocurrency market, the so-called "whales", who want to accumulate Bitcoin and other cryptocurrencies at lower prices. It is also possible that investors are uncertain about the future of regulation in the United States, in the face of the Biden administration's attempt to subdue the market.

Is this just a correction?

It is mainly the derivatives market that is behind the falls. What is more, the value of contracts has fallen by about a third, which means that the chances of a similar speculative attack have diminished significantly. There was also a rebound in prices quite quickly. Bitcoin has gained almost $10,000 since the bottom, and Ethereum has already reached over $4,000. It is also worth noting that the "fear and greed" index for Bitcoin, which is compiled by Alternative.me, indicated a value of 16 points (with a scale of 0 to 100) after Monday's sell-off. Often, sentiment indices can be used as contrarian indicators, particularly at extreme values. The index reached its lowest levels since the summer, when the previous massive downward wave ended. All these factors suggest that this could have been just a short-term correction, although the crypto market can surprise, even more than the weather.

Michał Stajniak

Senior Financial Markets Analyst

XTB

michal.stajniak@xtb.pl