On Thursday last week, Ethereum completed the biggest software update in cryptocurrency history as the merger finally took place. Everything went smoothly, exactly as it was written.
In the week that followed, Ethereum lost 12% of its value.
Jerome Powell moves the market
This shows that even an event as huge as the merger is not enough to overcome what really controls the markets: the macro situation. And by macro situation, I mean how Jerome Powell and the Federal Reserve are reacting to it.
The Fed announced another 75 basis point rate hike, largely boosted by last week’s disappointing inflation reading. The message to the market is now very clear: interest rate hikes will continue intensely and rapidly until inflation is brought under control.
And if there was any doubt before, there certainly isn’t now: cryptocurrency will follow these interest rate hikes.
Why do interest rates control cryptocurrency prices?
Cryptocurrency remains as risky as possible. The further you move away from the risk spectrum, the more volatile the moves, both up and down.
Raising Fed rates makes it more expensive to borrow and invest, which serves to draw liquidity out of the economy. This slows inflation while threatening a recession, which is the tightrope the Fed is trying to walk.
Stocks fell in response to this, especially high-growth stocks and technology stocks, whose future cash flows are traditionally discounted more. If these discount rates increase, the value of companies today is lower, and therefore the stock price goes down.
For cryptocurrency, despite many stories about inflation hedges, it’s not there yet. The correlation between the stock market and cryptocurrency is sky-high, and the two have moved in tandem.
What does the future hold for us?
I’ve written a lot about this recently. Although I believe in Bitcoin in the long term, there is no getting around the fact that in the short term price action is macro driven.
Personally, I’m very negative about the direction of the economy and I think the winter could be really bad. If this prognosis comes true, Bitcoin will follow the rest of the market down.
In a crisis, the correlations go towards a whole because there is a flight towards quality at all levels. Investors are selling risky assets and flocking to safe havens. This is part of the reason the dollar is so strong, as it is considered the safest of all safe-haven assets.
This is a trend we have seen time and time again in previous recessionary periods. For crypto, this is the first macroeconomic downturn it has experienced in its short history. And right now, even with positive events such as the merger, the broader movements in the economy are the only thing that matters for the price action of cryptocurrency.