Hi there!

We thought you’d like to be looped in to the latest market analysis that we prepared for our Coinbits Reserve clients. Coinbits Reserve is a concierge service for businesses and larger investors. However, we wanted to share this information publicly, to help you move confidently into 2022 and beyond on your bitcoin journey.

– The Coinbits Team

We’ve had an eventful start to 2022 with a number of people asking us about what is going on with the price of bitcoin. Bitcoin’s fundamentals remain strong. However, there’s been a slew of negative news putting price pressure on Bitcoin for a number of weeks now. The good news is, we are seeing the market support bitcoin at about $40K.

Although bitcoin is off to a rough start to the year, there is cause to be optimistic for 2022 and beyond. In this piece we will unpack the reasons that the price of bitcoin has been especially volatile lately, and provide our thoughts at the end.

What’s Happening:

Year-End Profit Taking & Tax-Loss Harvesting

Investors realizing profits or making portfolio adjustments for tax purposes

Easy Come, Easy Go with Leverage

Traders using borrowed money which creates short-term volatility

Fed Policy Jitters

The latest on Inflation and the Federal Reserve’s policy plans

Macro Events

China sell-offof cryptocurrency, Omicron/Covid fears, and Kazakhstan instability

Year-End Close Out

Bitcoin has been one of the best performing asset classes over the past decade, and 2021 was no different.

Although bitcoin finished the year in a downward trend, investors who bought in early or during price dips went into the final months of the year with big returns. This caused some fund managers to sell their “winners” at year end to realize gains and take profits. Profit taking results in a pull back in the short-term but prices generally recoup these losses.

Conversely, the less fortunate funds that recorded losses were able to take advantage of a different opportunity unique to cryptocurrency that is related to tax-loss harvesting. Tax-loss harvesting is a strategy to avoid capital gains tax liability through the selling of securities or assets. To understand how tax-loss harvesting affects the price of bitcoin, we have to first understand something known as the wash-sale rule.

When an investor sells a security that has decreased in value in order to claim a loss for tax purposes, only to buy it right back, it’s called a wash sale. The wash-sale rule generally prevents this by prohibiting investors from selling and repurchasing the same security within 30 days.

However, the wash-sale rule doesn’t apply to cryptocurrency. Many investors who understandably want to take advantage of this are thus incentivized to temporarily sell bitcoin at the end of the year. They sell bitcoin at a loss, claim a deduction, and buy back whenever they want. When funds with large amounts of bitcoin do this, they apply downward pressure to the price of bitcoin in the short term.

Easy Come, Easy Go with Leverage

We’ve discussed excessive leverage in the past, so we can keep this short. Leverage amplifies the potential outcome of a deal, and is created with money borrowed from a market maker or exchange (debt).

For example, if a trader uses 10x leverage to purchase an asset, and the price of the asset goes up, the gain is for the trader is magnified by 10x. This also applies to losses.

What we may have seen at the end of 2021 was a cascading effect. First, tax-loss harvesting caused downward price movement, which in turn caused lenders to force excessively leveraged positions to liquidate (sell) in order to cover their losses, further pushing the price of bitcoin down.

Fed Policy Jitters

If you find it, well, “interesting” that market behavior seems highly dependent on decisions from a small committee of powerful central bankers, you are not alone. The interest rate set by the Federal Reserve on federal funds influences other interest rates, such as those for credit cards and car loans. It also has a strong effect on markets. Investors see interest rates as a leading indicator of market performance because it determines the cost of leverage.

If borrowing costs decrease (because of low interest rates), conditions become favorable for growth and markets respond by pushing asset prices higher. The opposite takes place when interest rates, and borrowing costs, increase.

Last week, the Federal Reserve released meeting notes that indicated they are considering raising interest rates, causing investors to expect lower growth in the short term.

Another issue at play has to do with bonds. Stocks, as well as assets such as bitcoin, have been off to a rough start this year as government bond yields continue to rise. The Federal Reserve is effectively decreasing the price of bonds by slowing bond purchases and reducing their $8 trillion balance sheet. The market is reacting strongly to this signal, with Nasdaq down 10% from its all time high and the stock market sell-off expected to continue on Monday.

So, why is the Federal Reserve signaling such a strong policy reversal? It comes down to inflation. The current rate of inflation acknowledged by the government implies that consumer prices are rising at their fastest pace in 40 years. The real rate of inflation is almost certainly higher. Inflation has been much more persistent and intense than the government predicted when it decided to dramatically expand the money supply during the pandemic, and it is under intense pressure to do something about it.

Controlling inflation comes at the expense of market growth. The question is, how will the Federal Reserve balance damage to markets with allowing further inflation? Neither choice is good.

Keep in mind, the central bankers at the Fed didn’t raise interest rates, they just announced that they were thinking about it. With the markets already reacting so negatively to a hint of a rate hike, what might happen if they implement the policy?

Nobody knows, but one thing is for sure. We are once again seeing the negative consequences of centralized economic decision making. Over the long term, more and more people will understand how bitcoin can solve these problems or even avoid them altogether.

Trading Banned in China

In September, the Chinese government again cracked down on cryptocurrency mining and trading. Although these kinds of official bans in China have become commonplace, this latest one imposed a rule that made crypto trading illegal.

Several bitcoin exchanges and crypto-related companies have since cut ties with China. This triggered an unprecedented amount of selling in the final months of the year, with markets trading significantly lower during Asian business hours.

With the government having made access to crypto more difficult, many holders of renminbi are looking for an opportunity to come back into the market, legally or otherwise. It’s a matter of when, not if, much of this capital finds its way back into the bitcoin economy.

Unrest in Kazakhstan

China’s ban has other implications as well. When mining was banned there in summer, many Chinese bitcoin miners found refuge in Kazakhstan. This gave the central Asian country the second highest hash power in the world, behind only the U.S.

Kazakhstan’s abundant energy proved to be a boon for the bitcoin network. However, in recent weeks, political instability resulted in electricity and energy market disruptions, and eventually a nationwide internet blackout.

During the unrest, the hash rate of top mining pools dropped 11%, but this has already recovered to 2.2% below December’s rate. However, the continuing uncertainty in the region has prompted some miners to look overseas to continue their operations.

If Kazakhstan-based miners do relocate en masse, we will likely see a short term drop in hash rate similar in duration but smaller in magnitude than the one caused by the migration out of China in summer. When miners relocate they often sell bitcoin to pay for expenses, which causes downward price pressure. How this plays out remains to be seen.

Covid Confusion

Finally, a price analysis wouldn’t be complete without considering the latest pandemic news. Covid has unfortunately continued to prompt market volatility across many asset classes as disease variants and unpredictable government responses cause fear and confusion. Bitcoin is still considered a “risk-on” asset by many investors who do not understand it. In times of worry, many choose to limit their exposure to bitcoin and seek “safer” places to park their capital. The good news is that the latest Covid variants are turning out to be less severe than initially feared, so we may soon see a reduction in Covid confusion and resultant market volatility.

Our Thoughts

Year-End

Bitcoin’s superiority to other asset classes doesn’t come without short-term risk. When bitcoin outperforms the rest of the market, investors will tend to sell when the opportunity presents itself to realize profits. These phenomena aren’t concerning to long-term hodlers like ourselves and our clients, and actually give us the opportunity to purchase inexpensive bitcoin.

Leverage in the Markets

We believe the liquidation of leveraged positions are a painful, yet healthy cleansing of aggressive and risky market actors. Dollar-Cost Averaging is one of the best investment strategies to protect against the volatility that comes from traders utilizing leverage, as investors are able to smooth out their cost basis over time, rather than just buying at a single price point.

Fed Policy & Inflation

Tightening comes with a cost. Raising rates to increase the cost of capital has reverberating effects across the entire economy, including, but not limited to, servicing interest payments and a large reduction in consumer spending. We believe this talk is mostly that, just talk. We will see the Fed taper and potentially hike rates, but the economic consequences will force them to pull back. An easy money environment complete with inflation will trigger investors to seek safety in scarce assets, the scarcest of them all being Bitcoin.

China, Kazakhstan & Covid

As we saw with China’s earlier mining ban that resulted in 40% of the network hashrate going down for a short time, these situations tend to make the network stronger. We’ve discussed Bitcoin’s anti-fragility in the past, that is, the more attacks it endures, the stronger it becomes. Witnessing a flow of miners from China to the United States was a great example of Bitcoin’s anti-fragility. Similarly, we’re already seeing Kazakhstan come back on line in spite of the initial downtime.

Thank you for reading. We remain bullish for 2022 and beyond, and are glad you are with us on this incredibly exciting journey.