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Crypto mkt has recovered 25% since Fed’s March FOMC meeting.

Sustainable rally or dead cat bounce? 👇

First off, why did risk assets sell off this yr & then bounce after FOMC meeting?

Several factors.

Balance sheet expansion from central banks slowed down big time in 2021—> lower momentum of liquidity growth—> lower momentum of risk asset rally

Then financial conditions started tighten as inflation & commodity prices went up & central banks around world began raising rates. ~15 CBs have hiked. More are abt to soon.

Though Fed hasn’t shrunk balance sheet & barely raised rates, it’s started reigning in liquidity. Base money has dropped…

…while reverse repos, taking liquidity out of banking sys, have grown.

There’s also obv Ukraine which triggered risk-off moves.

However, magnitude of actual damage to mkt liquidity from all above does not justify whopping 20% selloff of Nasdaq in 1+ mo. Mkt was front-running the tightening of financial conditions.

The overreaction was bound to correct itself when given a trigger. FOMC March meeting hiked 25 bps & gave more clarity to tightening path going forward, plus it wasn’t more hawkish than expected— a perfect opportunity for mkt to “sell the rumor & buy the news” & it did exactly that.

Risk assets including crypto bounced nicely after. But so far it’s simply mean reversion from lows. To see how sustainable the rally is, let’s look at both bearish & bullish factors that may affect crypto in next 6-9 mos:

BEARISH FACTORS

1. Monetary policy continues to tighten

W/o question more tightening will & should be the path forward for at least next 6 mos w/ unemployment v low & inflation at generational high. This & decreasing mkt liquidity will hurt crypto, which are mostly still risk-on assets.

You say, world is too indebted for Fed to tighten much. That’s true but so what? You’re not gonna see Fed back off until serious distress in mkts. And given mkts welcomed 1st rate hike w/ open arms by recovering nicely, we’re not gonna be in ‘back-off’ territory anytime soon.

2. High inflation squeezes investment inflow

Inflation not only makes future cash flow discounts steeper, hurting growth investments like web3, it also leaves less disposable cash in people’s pockets to buy tokens since you need to spend more on real life necessities.

You say, bitcoin is supposed to be “inflation hedge”, so shouldn’t high inflation be good for crypto?

It shouldn’t.

Inflation hedges like gold protects from monetary inflation caused by too much printing. it doesn’t protect from inflation caused by supply chain problem & commodity shortage. (when you have a food shortage, are you gonna eat a gold bar or bitcoin instead?)

Inflation now is & will increasingly be of the latter kind.

3. “Recession” in blockchain economies

If you read my earlier writing, I talked a lot abt blockchain platforms as metaverse national economies. In 2019/20, we had major innovation waves in DeFi & NFT, i.e. high “productivity growth” period in on-chain economies.

Meanwhile new L1/L2s helped to expand “territory” & “population” of overall blockchain universe. These progresses manifested in bullish price actions in 2020/21.

Since mid 2021, innovation & horizontal expansion have slowed. Ethereum economic activities peaked in May last yr.

Bitcoin activities dropped even more.

You say, surely newer chains are still growing? Well let’s see.

Polygon is def in recession & a pretty deep one.

Near has never had very fast growth except short periods of bursts likely b/c of temp incentives.

Avalanche has had one of the most sustainable growth. Still, momentum has slowed since this yr.

Arbitrum shows more sign of life than last yr but I wouldn’t call it a boom.

We can look at more chains but you get the idea. Global metaverse economy is in a down cycle. Growth has slowed, so has demand. ’Tis driven by mkt reflexivity but also by slowdown of innovation/productivity. And next wave of adoption catalysts hasn’t arrived just yet.

BULLISH FACTORS

1. Geopolitical uncertainty prompts higher demand for financial sovereignty

Sanctions related to Russia/Ukraine are heightening awareness of the importance of financial sovereignty. It’ll help boost adoption of trustless financial system built on blockchain.

But that’s a gradual process. while inflation/monetary tightening is a freight train coming your way rn. The former is not a sufficient countervailing force to the latter in short term.

2. Continued institutional adoption

Institutional trading volume in crypto has increased from ~30% of total crypto vol in 2020 to 70% now. More institutional adoption will def be coming.

But again ’tis a gradual process, while in short term speed of institutional money inflow is negatively affected by tightening global liquidity.

3. Real economy recession leads to new round of monetary easing

Indicators from PMI to housing are showing that US economy is off peaks. High inflation hurts demand & may accelerate the down trend (’tis why they say the cure of high prices is high prices).

Eventually we’ll hit a recession & Fed will need to start easing which’ll be bullish for risk assets including crypto.

But high commodity prices arguably hurt US less than many other countries that are much bigger importers of raw materials. And we’re still far away from any recessionary territory.

So I’m afraid anybody that uses potential recession as a bullish argument has bad sense of timing. Eventually, yes. In next 6 mos? Prob not.

4. Blockchain gains more real life use cases

Next wave of crypto adoption will come from integrating blockchain into real economy use cases. I’m starting to see more & more quality projects attempting this.

These won’t be overnight successes & likely won’t show in price action in short term. But I have no doubt in next couple yrs we’ll see huge adoption waves prompted by more accessibility of crypto products in real life.

(BTW, like this so far? I write about ideas on investment, macro and human potential. Subscribe to my newsletter for updates.)

How will it play out?

In immediate term we’re due for rebound as FOMC March meeting gave clearer forward guidance of monetary actions & mkts mean-revert from oversold.

I wouldn’t be surprised if BTC goes back to $50k+ shortly b/f next FOMC meeting which is early May. If no quantitative tightening is announced in May while rate hike schedule keeps at 50 bps, there may even be more rally.

W/ BTC rebound, alt token rotation will follow. I posted this a wk b/f FOMC meeting, which has played out almost to exact timing but ’tis def more luck than genius:

I don’t expect any of that to sustain as we’d prob have increasingly tight financial conditions & aggressive central banks next 6-9 mos. If BTC does not break current range low of ~$30k in this time frame, I’d consider that an extraordinary outcome.

In other words we prob haven’t seen the cycle low yet. I hope that doesn’t depress you. Cuz I personally am more optimistic abt web3’s future than ever after Avalanche conference I just went to:

I also believe a proper bear mkt in short term would be good for sustainable growth of this industry. If that happens I hope you have the patience to stick around b/c the future is as bright as ever.

 

8 Comments

  1. Wonderfully insightful! Thank you Tascha for your great work!!

  2. digital_everest Reply

    Thanks Tascha, this was an excellent update. Really useful perspective and macro level insight. The data showing the slowdowns in blockchain growth was especially interesting. Nice work!

  3. Not difficult to form a reasonable view of the long term and short term trend given there are strong macro drives behind both of them. But this analysis is comprehensive, including crypto specific factors I haven’t heard elsewhere, rather than merely lumping it with tech stocks. Very insightful! Thanks for sharing!

  4. Did you just left Solana out of your L1s examples on purpose or lack of time?

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