Over the past week, the crypto market has taken a hit due to the usual Fear, Uncertainty, and Doubt (FUD) surrounding the potential for interest rate hikes and future regulations. It’s easy to get sucked into the panic and feel that crypto is being unfairly targeted.
FUD is part and parcel of the crypto space and there are always plenty of narratives that accompany its volatility. In 2021 the favorite topic was China’s negative approach to crypto. Fast forward to today and Bitcoin miners are back operating in China and the government is seeking to make Hong Kong a regional hub for crypto.
Meanwhile, the narrative has now switched to the negative approach the US government is taking toward crypto. The failure of Silvergate Bank is being attributed by some to a conspiracy involving the Federal Reserve because they were potential competitors to the Fed’s upcoming payment system.
When we focus on just the crypto market there’s a tendency to see patterns that accord with the usual narratives. If we zoom out and look at the situation in a wider context it’s easier to see that the current turbulence is affecting all markets.
For instance, many people have focused this week on the collapse of Silvergate Bank because of its close ties to the blockchain industry. While this certainly has an effect on the crypto market it isn’t the only bank in trouble.
On Thursday, shares in Silicone Valley Bank (SVB) plummeted by 60% before the close of trade and dropped another 20% after trading. The contagion from this event wiped $50bn off the value of the four largest US banks. It also hit banks in Asia and Europe wiping an average of 5% from their value.
The reason for the drop in value of SVB is that they had to liquidate some of the US Treasury bonds they hold, leading to a loss of $1.8bn. US bonds are held by banks throughout the world as a form of highly liquid security. The problem of bonds arises for banks when the Federal Reserve raises rates which makes the bonds they hold become less valuable.
Due to the nature of fractional reserve banking, banks only need to hold a fraction of their balance in highly liquid assets. Normally this isn’t a problem, however, when confidence drops and people withdraw funds en masse the bank has to liquidate some of their assets to pay the withdrawals.
This week Jerome Powell, head of the US Federal Reserve indicated that inflation was still a problem and that they would have to raise interest rates faster and longer than previously thought. While this had a negative impact on crypto it also had a much bigger negative impact on the banking sector.
Speaking with the BBC, Ray Wang, founder of Constellation Research said, “The banks are casualties of the hike in interest rates…Nobody at Silicon Valley Bank and in a lot of places thought that these interest rate hikes would have lasted this long. And I think that’s really what happened. They bet wrong.”
While the problems at Silvergate are related to the far-reaching effects of the FTX collapse and some of their previous investment choices, the continued interest rate increases by the Fed add to their woes. The liquidity crunch that monetary tightening creates is intended to crash the economy in the short term to benefit its longer-term health.
As we’ve said many times before the volatility of the present bear market will likely continue for a few months. Rather than getting pulled into guessing when the next bull run will be and the despair of false hope, it’s better to zoom out and see the turbulence in the wider global context. This helps to maintain confidence that things will change whilst avoiding the frustration of relief rallies and dips.
Whatever the surface narrative, the underlying truth is that bull runs need liquidity and that will only come when the Fed starts to lower rates. Until then it gives everyone more time to gradually accumulate tokens in preparation for the next phase of the cycle.