Bitcoin And Ethereum Crashed And Recovered Before. Will They Do It Again Now?

By Diego Colman of DailyFX.com

Monday, November 14, 2022 4:27 PM EDT

Bitcoin (BTC/USD) and Ethereum (ETH/USD) have plummeted about 75% from their all-time highs set in November 2021, as speculative appetite has greatly diminished against a backdrop of high inflation, rising interest rates, mounting recession risks and several crypto-related scandals.

Cryptocurrencies have crashed and recovered before, so it is natural to wonder if the same cycle will repeat itself. For example, both Bitcoin and Ethereum plunged more than 80% from peak to trough in 2018, but then went on to rally to fresh records in the next 36 months.

Could something similar happen this time around? It's hard to say for sure, but the conditions that spurred the 2020-2021 bullish explosion have faded. During that period, governments and central banks around the world flooded their economies with liquidity to minimize the damage caused by the coronavirus healthcare crisis and to avoid lasting economic scars.

The chart below shows how the money supply in the U.S., China, the euro area, Japan and the U.K., as measured by M2, has increased in recent years. From February 2020 to February 2022, M2 grew by about $20 trillion to $91.45 trillion, more than in the previous seven years combined.

MONEY SUPPLY (M2) FOR SELECTED COUNTRIES AND REGION

(Click on image to enlarge)

Chart, line chart Description automatically generated

Pandemic-related stimulus fueled a voracious speculative frenzy that swept across markets, propping up most assets, including digital tokens. But now, the outlook is becoming more hostile, with monetary authorities around the world rapidly withdrawing accommodation to fight inflation. The Fed, for example, has raised rates by 375 basis points this year, embarking on the most aggressive tightening campaign since the 1980s.

With an increasingly restrictive monetary policy posture and a more austere fiscal position by several governments, risk assets will continue to struggle in the short term, but cryptocurrencies will face another headwind: loss of trust. Recent scandals, such as the FTX downfall, have damaged confidence in the industry, which may take years to restore.

Extreme volatility in the space will also impede further adoption, as institutional investors will be ever more reluctant to include cryptocurrencies in their portfolios as a diversification strategy, considering their high-risk market structure. Recent price action moves have also debunked the idea these tokens can function as a safe haven in times of market stress.

In the current environment, Bitcoin and Ethereum may remain biased to the downside in the near term. On a longer-term horizon, a rebound remains a possibility considering the disruptive nature of blockchain technology, but any recovery is likely to be quite slow and non-linear as the era of easy money fades into the distance.