Is this the beginning of the end or the end of the beginning for Bitcoin and the cryptocurrencies movement?

Published On: May 16, 2022Categories: Alternative Investments7.4 min read

Last week Bitcoin lost over 20% of its value with a 10% drop on Thursday alone, briefly taking the original and market-leading cryptocurrency’s value below $26,000 (circa. £21,000). It has since recovered to a little under $29,630 but has still lost more than half its value since a record high of $68,991 (£56,512) set last November.

The rest of the cryptocurrency and digital assets market has suffered a similarly sharp decline since the end of last year, widely reflecting the flight from risk that has hit tech sector growth stocks hard. Last week Ether, the second largest cryptocurrency and connected to the Ethereum smart contracts blockchain platform, lost 26%, while Solana and Cardano, two smaller cryptocurrencies, lost 41% and 35% respectively.

bitcoin to usd

Source: CoinMarketCap.com

At its historical peak in November last year, the global cryptocurrency market was worth around $2.9 trillion. It is currently worth around $1.2 trillion. That represents a decline of almost 60% and means any investors more heavily exposed to cryptocurrencies and digital assets like NFTs, which have also seen their valuations routed, will have lost considerable sums. Especially anyone unfortunate enough to have invested towards the peak of the market.

The steep losses are problematic for the cryptocurrencies market in more, and deeper, ways than a market crash, painful as they can be. Recent losses have not only shown correlation to the slump in stock markets, especially for growth stocks, but have exceeded them. The tech-heavy Nasdaq 100 is down 25% for the year-to-date while Bitcoin is down almost 37%, Ether over 45% and Cardano by almost 60%.

Those losses are difficult to reconcile with the narrative that has underpinned the rise of cryptocurrencies over the past several years. Bitcoin, and then the multiple other cryptocurrencies and tokens built on the digital ledger blockchain technology it introduced, were supposed to offer an alternative to the perceived failings of traditional financial markets.

Cryptocurrencies were supposed to be the antidote to high levels of inflation hurting growth stocks because it means the future revenues aggressive valuations rely on are suddenly worth less. And are less certain with recession now broadly expected across much of the world.

Because the number of Bitcoin, and the other cryptocurrencies that followed it, is capped from the beginning (in the case of Bitcoin the cap is set at 21 million), it was positioned as an inflation haven. Fiat currencies like the pound, U.S. dollar, euro and yen, lose value when central banks print more as part of the quantitative easing policies designed to stimulate the economy that have become almost baked into developed economies since the financial crisis of 2007-08.

The amount of money printing that spurred the economic recovery from 2009 onwards, a strategy that was again powered up when the Covid-19 pandemic struck, has been seen as an inflation risk in some quarters for years. For a while, it looked as though the Fed, Bank of England, European Central Bank and other major central banks might have managed to tread the tightrope.

But supply chain issues resulting from pandemic interruptions last year saw inflation start to rise into dangerous territory. That was compounded by the outbreak of war in Ukraine this year after Russia invaded its neighbour in late February. Economic sanctions brought against Russia, and Ukraine being thrown into chaos by a war on its territory, pushed up the prices of energy commodities, metals and agricultural commodities.

inflation rate uk

Source: ONS

That has seen inflation spiral out of control from a little over 6% in the UK in February, still triple the 2% target, to an expected 9% this week when figures are published. The Bank of England now expects it to peak at over 10% in the early summer and most economists expect rates to remain elevated for the next couple of years.

Bitcoin and other cryptocurrencies, for whom the rate of new units being minted and introduced into the market can’t be changed regardless of external factors, were supposed to be a safe haven from fiat currency debasement. Instead, their exchange values have slumped by far more than the loss of purchasing power experienced by fiat currencies over the same period.

Why have Bitcoin and the wider cryptocurrencies market lost so much of their value?

It turns out the cryptocurrency valuations, like the naysayers said all along, were firmly in bubble territory, driven up by the kind of speculation that is always so obvious as soon as the bubble has burst. And they haven’t proven a hedge against inflation at all. In fact, quite the opposite; inflation has been the root cause of their sharp decline.

The inherent, immutable scarcity of cryptocurrencies hasn’t helped them preserve their value through high inflation for one simple reason. Cryptocurrencies are not used as currency. You can’t actually buy anything with them. Or at least not much.

That means, at this stage of their development, cryptocurrencies behave more like a commodity than a currency. But a commodity that has no innate value because it can’t be used for anything, like oil, iron ore, or wheat are used to provide power, build things or be consumed as food.

That realisation has seen Bitcoin and other cryptos instead compared to gold as a digital store of value. Gold also has little practical use other than as jewellery and to a limited extent as a conductor in some electronics. Gold’s price is mainly influenced by the demand for it as a store of value. Which is why it tends to rise when financial markets crash.

But gold’s role as a commodity that acts as a store of value has been ingrained in human culture and economics for millennia. When push has come to shove over the past several months, financial markets have shown they don’t believe in Bitcoin’s inherent worth as a store of value, as a digital alternative to gold.

And right now, cryptocurrencies have no other practical use. Bitcoin can’t be used as a currency, nor can other cryptocurrencies. Ether and XRP, the cryptocurrencies that power the Ethereum and Ripple (a blockchain-based financial clearing system) blockchain platforms, theoretically have some practical utility.

But these blockchain platforms have not become embedded in the everyday economy in the way their proponents expected them to become. Plenty of big companies are or have experimented with blockchain systems. But at least for now, these initiatives remain pilot projects and many have been abandoned altogether.

Overall, blockchain technology remains at a nascent stage of its development and there isn’t a single blockchain solution that is strategically crucial to any company in the real world economy outside of the crypto space. That limits demand for their tokens other than from financial speculators. And the fact pure cryptocurrencies like Bitcoin, designed and positioned as an improved alternative to fiat currencies, still have little to no practical use in the real economy means their value was also reliant on demand from speculators.

A bubble occurs when the value of an asset is in the majority founded on a speculative future, rather than genuine economic fundamentals. That’s why the valuations of high growth technology companies have dropped so significantly this year. And why companies still to generate a profit, or even much revenue, have been hit hardest.

And it’s also why cryptocurrencies have plunged. They are, it has suddenly become clear, comparable to the electric vehicle companies that were valued at billions last year without having so much as a working prototype to support investor optimism for their future.

Will cryptocurrencies bounce back more sustainably like online business models after the dotcom crash?

None of that is to say what we are seeing now is necessarily the beginning of the end for cryptocurrencies and blockchain technology. The fact that it is now patently obvious valuations were in a massive bubble doesn’t mean cryptocurrencies, digital assets and blockchain have no future.

The most obvious parallel is that of the bursting of the dotcom bubble in 2000. Online businesses that ran at a loss and generated minimal to no revenues were valued at tens and hundreds of millions by investors convinced of their future potential. It turned out they were right. Just a decade or two early.

nasdaq composite

The chart above of the Nasdaq composite clearly shows the rise then fall of the tech-centric exchange in the runup to the bursting of the dotcom bubble in 2000. While there was something of a recovery between 2003 and the onset of the financial crisis in 2008, tech valuations remained muted until roughly the last decade when the economy truly started to digitalise. That has led to the huge revenues the biggest tech companies like Apple, Amazon, Alphabet and Microsoft now generate.

Tech valuations again formed a bubble from March 2020 until the end of last year as a result of the Covid-19 pandemic and enthusiasm for the ‘acceleration’ of the digital economy. And also, it is now clear, heavily influenced by the cash central banks flooded the system with in an effort to mitigate the economic impact of the pandemic.

Cryptocurrencies, quite possibly a new regulated generation that prevents them from representing an easy option for money launderers and others involved in criminal activity, could make a similar recovery in years ahead. And blockchain technology could also evolve over the next several years and become integral to companies and other organisations including civil service departments.

But like tech companies after the bursting of the dotcom bubble, cryptocurrency and blockchain organisations will have to build back sustainably. And future valuations can be expected to remain much more tied to economic fundamentals.

At least until the next bubble forms.

About the Author: Jonathan Adams

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