As digital currency markets implode in real time, with hedge funds like Three Arrows Capital (3AC) going into liquidation and lenders like Celsius and BlockFi facing possible insolvency, it looks like another currency bear market digital arrived.
In this article, I will argue that the conditions are ripe for a long and protracted “crypto winter” from which many coins will never recover. As you will see, this is a multi-faceted problem with no easy solutions in sight.
Recklessness and the inevitable regulatory response
To say the actions of people like Three Arrows Capital were reckless would be an understatement. This hedge fund seems to have borrowed from every digital currency lending platform in the industry and leveraged everything it could get its hands on. Founders Kyle Davies and Su Zhu are paying the price now, and they’re blowing holes in the balance sheets of some of the industry’s biggest lending platforms as they rapidly rush to the end.
However, Three Arrows Capital is not the only culprit here. As we’ve learned over the past few weeks, nefarious characters like Roger Ver were also (allegedly) irresponsible, and Michael Saylor’s (NASDAQ: MSTR) MicroStrategy got dangerously close to margin calls on some of its loans. Even the president of a sovereign nation, El Salvador, plundered his country’s treasury to participate in the world’s largest pyramid scheme and is now losing tens of millions of dollars.
All of this madness has led to a series of events that will almost certainly prompt regulators to step in and prevent it from happening again. While the industry is not yet big enough to pose systemic risk in major economies, innocent consumers are finding their funds locked up in platforms like Celsius, BlockFi and Voyager as these platforms desperately try to stay afloat. Unfortunately, most will never see their hard-earned funds again. The backlash will be severe.
When regulators step in and write new laws to prevent a repeat of the digital currency crash of 2022, it will mean that the leveraged long positions and laissez-faire lending/borrowing that enabled the surge in 2020 -2021 will no longer be possible. Honestly, I’d be surprised if a few people didn’t serve their time for what happened and what hasn’t happened yet.
Inflation and the reaction of central banks
It was likely apparent that inflation would become a major issue as central banks turned on the turbo printer as global supply chains simultaneously came to a halt during the pandemic. Hindsight is 2020, as they say, and regardless of who was right or who saw it coming, here we are.
In response to the worst inflation in decades, central banks such as the Federal Reserve have made it clear that they plan to raise interest rates aggressively. They have to, but it puts intense pressure on ordinary people, and if not dealt with quickly, political discontent will likely turn into civil unrest.
What happens to risky assets when central banks raise rates? We watch him play in real time. BTC has fallen from a high of over $60,000 in November 2021 to barely $20,000 in June 2022. So much for the “inflation hedge” narrative. Meme stocks like Tesla crashed and the S&P 500 entered bearish territory. Some other digital currencies have fallen even more than BTC, and as happened in 2017, many of them will never rise again.
However, this is only the beginning. The Federal Reserve has made it clear that it will continue to raise rates aggressively until inflation is brought under control. As the yield available on Uncle Sam bonds increases, they will continue to become more attractive. Institutional investors who may have thought about allocating funds to risky assets like BTC will park it where they know the ROI is improving and the ROI is 100% guaranteed.
Expect the vast majority of institutional capital to leave the digital currency space until this trend reverses, or at the very least, don’t expect to enter it anymore.
A quick note about boomers
Demography plays a huge role in every economy, and the western world is on the verge of a tectonic demographic shift. The largest generation in history, baby boomers, are set to retire in droves over the next two to three years. When they do, their economic behavior will change dramatically. Retirees are generally risk averse. Baby boomers will take their capital off the table and put it into the aforementioned bonds and perhaps some safe blue chip stocks.
As that capital disappears, things will get even tighter, and what’s left will mostly be allocated to real productive businesses and not digital nuggets. The era of easy money and abundant capital is over in more ways than one.
Rising energy costs – we haven’t seen anything yet
Rising energy costs are one of the sad consequences of a combination of current factors; inflation, war, poor preparation and some opportunistic profits. We can argue all day about which factors play the biggest role, but truth be told, it doesn’t matter. Prices at the pump continue to rise, as do the costs associated with heating or cooling our homes.
Yet it is entirely possible that energy prices will continue to rise and double again by the end of the year. Geopolitical consultant and best-selling author Peter Ziehan explains why in this video.
In short, Russian pipelines will not sustain themselves, and with the mass exodus of oil service companies like Halliburton, Schlumberger and others, coupled with potential pipeline damage from the ongoing conflict, the lines that carry between 4 and 5 million barrels of Russian crude oil per day will slowly break down and deteriorate, and it will be a very long time before they come back online. The last time this happened was when the Soviet Union collapsed, and it took 30 years to get back to peak production just recently.
Contrary to popular belief, oil-rich countries like Saudi Arabia, Venezuela, Iran and the United States cannot magically bring in millions of barrels a day to replace Russian crude. It can take years to go from drilling a well to production, so oil prices are likely to rise significantly in the short to medium term.
This will have all kinds of implications. Directly, this will have an even greater impact on prices at the pump and will massively increase the cost of transporting goods and services around the world, causing the prices of everything to slowly rise as companies try to cover the difference. Ordinary citizens will not speculate in digital currencies such as BTC, ETH or other altcoins, as they will try to put gas in their car to get to work while paying for more expensive groceries.
Of course, Bitcoin doesn’t run on thin air either. The global mining industry depends on the same supply chains, transportation systems and energy as everyone else. We are already seeing miners under pressure as many throw away the coins they were holding to pay the bills. Any further increases in energy prices, transport costs, etc. will only make the situation worse. It’s also possible that when energy prices really start to bite, digital currency mining will either be banned or severely restricted in many different places.
How could I be wrong about all this?
It’s important to remember that this is just a thesis, my reflection on how things are going to unfold in the next couple of years. I don’t have a crystal ball and I could be wrong.
It is possible, though in my view unlikely, that inflation will soon be brought under control and that the Federal Reserve and other central banks will ease monetary policy, cut rates and start the easy money carnival all over again.
It is also possible that the Russian-Ukrainian conflict will end quickly and that a compromise will be found to keep Russian crude oil in circulation so that energy prices do not skyrocket further.
Similarly, regulators could decide light rules are the way to go, leaving Tether to print tens of billions more with little oversight, causing digital currencies to pump again.
In my view, none of this is likely. Back in the real world, inflation is not transitory, the sad war in Ukraine will not end anytime soon, and regulators will trample the digital currency industry.
Winter is here, and it’s going to get much colder in the months and years to come. Only utility blockchains will survive.
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