Is Crypto Close To A Bottom

I doubt many of you are very interested in hearing about crypto right now. Most people got interested about this time a year ago and if you fell into the thanksgiving crowd you are down bad just a year later. There is no doubt this has been a brutal market to navigate. Even the seemingly smart money got blown up and caught offsides. With the most recent implosion in FTX this last month, mainstream investors want nothing to do with crypto and even the faith of some of the industry veterans has been shaken in a meaningful way. So where does that leave us? Are we close to the end of the storm or is it just beginning?

In order to understand that we need to look at the overall state of the economy and the liquidity situation we are in. Crypto as an asset class is highly correlated with liquidity and appetite for risk. Right now we are experiencing major declines in both. The Federal Reserve is currently in the process of raising interest rates and draining its balance sheet in a process known as quantitative tightening. In short this means they are taking money out of the economy and doing it at a faster rate than any time in history. This comes just after they practiced looser monetary policy at any point in history. So safe to say they are playing the extremes and we shouldn’t be surprised at extreme outcomes.

So far, this policy has spiraled us into an inflationary bear market. In inflationary bear markets there are usually three phases. First, is the initial top and crash as the fed starts to shut off the water to the economy by tightening policy. The second phase which we are in now is the rally phase. You can see this playing out better in the stock market with the two big rallies that have happened this year.

These rallies are steep and capture big upside and can go farther than anyone anticipates. They are designed to shake out the shorts and make investors confident that the bottom was in. Then comes the third stage where real panic begins as the economic outlook truly takes an ugly turn into full blown recession as people realize the fed overstepped its tools and the economy is suffering severely. As I said, we seem to be in the second stage of this market right now with another big panic still to come.

When that panic will unfold is anybody’s guess but if you have to make a bet the first half of next year seems like a pretty good target given that we are roughly 10 months in to a bear market which usually vary between 16-22 months. I think it’s reasonable to expect a bottom in markets sometime in the next six months but the issue is that it can get a lot uglier first.

You see, the Federal reserve relies a lot on the trust of the public to do what they say they are going to do. Right now the market is jumping at any chance to call the fed on their bluff that rates will be higher for longer. But I don’t think the fed is going to budge until something seriously breaks. Their credibility is on the line and frankly if they stop tightening too soon the market panic could be even greater when the economy realizes that they didn’t squash inflation, yet let loose on their policy. Just like when the fed was so adamant about transitory inflation, do you think they are telling the truth now when talking about a soft landing? Well its my bet that they are wrong about that as well given the historically fast pace of tightening, but they wont tell you that until after the fact.

This is an environment that is not going to be kind to risk assets and with crypto being the king of risk assets the bottom is not yet in. It’s hard to say how ugly it could get given some of the risk factors out there. But barring any other major implosion it would not surprise me to see bitcoin in the 8-10k range and ethereum hit 600-800$.

Even so the mainstream sentiment on crypto is already at bear market highs. When you have press declaring crypto to be dead and major complacency among even the largest market participants its hard not to feel like a bottom is in. Usually, these are the signs you look for when “buying the blood” so to speak. However, since we know crypto is a risk asset and the current monetary policy is highly unfavorable to its outlook we must wait for a change in the bigger picture before we try to catch a falling knife.

That being said the most important takeaway is that crypto is far from dead. No matter what the talking heads on tv say crypto is much bigger than being just a currency. It is a technological innovation that has the ability to solve immense global problems from banking to supply chain issues. It will prevail and thrive in the years and decades to come and it’s not an opportunity you will want to miss.

Sure there are a few sour apples but so are there is the traditional banking system. In fact if anything the recent FTX drama proves that the problem lies in people and not the technology. The insolvencies in crypto have been no different than in the real financial world. Human nature makes people greedy and the centralized crypto exchanges are run by people. In that way they are at risk of greed working its way into their systems. Decentralized protocols however, run on code. There is no one there to get greedy and over leverage the books. The code simply computes what it was designed to compute and nothing more. It’s when you add human nature to the equation you begin to have problems.

Meanwhile, crypto DEX’s have been running along as if nothing happened. No bailouts necessary. In fact in spite of all that has transpired the industry has remained rather resilient. So don’t let people scare you away from another big opportunity. They told you crypto was toast in 2014, then again in 2018, now here we are in 2022. Do you really think this time will be different and crypto won’t recover? We know how that will end, as it’s never “this time is different.”

The biggest threat crypto faces going forward will be regulation. Right now its pretty unclear what this will look like but you can be sure its coming. It will probably be a net positive for the adoption of crypto because it will give clarity for institutions who want to invest. But overall it will likely jeopardize many of the key principles of the industry like self custody and decentralization. And depending on how they classify cryptos and nfts some projects may be at risk of being declared securities giving them major headwinds that many may not be able to resolve.

So what should you be doing and where should we be investing when the bottom is approaching? Thats what we will continue to monitor and update over the next few months. In the meantime its probably not the best timing to buy here so its best to be in cash and raising as much cash as you can to buy the lows. It’s worth noting things that are holding their value relatively well right now cause those will likely outperform next cycle.