Following its mercurial rise throughout most of 2021, the cryptocurrency market suffered a sharp correction in November. Initially, ardent supporters of blockchain-based enterprises saw this as nothing more than the usual (albeit notorious) sector volatility. Unfortunately, those that loaded up the boat around that time would go onto suffer a boatload of losses.
To be sure, several weak hands of the crypto market exited the arena as digital assets demonstrated little ability to stabilize. Roughly speaking, at the beginning of 2022, the total market capitalization of all cryptos stood at $2.23 trillion. By New Year’s Eve, this stat dropped to an alarming $794 billion. To be fair, the valuation at time of writing is just under $806 billion.
Still, 64% sector-wide losses are difficult to forget. And while it may seem as if the weak hands are no longer present in the market, even the strong hands are not guaranteed to hold the line indefinitely. For instance, you’ve got to imagine that at least a few market participants bid more than they should have. Thus, outside headwinds such as mass layoffs can turn strength into weakness very quickly.
That’s not to say that it’s impossible for cryptos to rise higher in 2023. However, it’s probably best to remain skeptical and allow the space to prove to you that it’s worthy of your hard-earned money.
Cryptos Face the Specter of Rising Rates
In my opinion, the biggest headwind for a recovery in cryptos in the new year centers on the Federal Reserve. As I demonstrated in my research for Barchart.com, the juxtaposition between the price fluctuations of the benchmark virtual currency and the real M2 money stock reveals a statistically strong, direct correlation.
In other words, as money supply rises (inflationary), so too does cryptocurrency valuations. As money supply tightens (deflationary), crypto valuations likewise decline. Essentially, blockchain assets act no differently than mainstream commodities or popular risk-on assets. If central bank policy favors growth, then growth-centric enterprises swing higher. If not, they deflate badly.
Moving forward, the challenge for cryptos is that the Fed indicated no signs of reversing its hawkish monetary policy. To be sure, some of the worst performances in the stock market hail from lending companies. It all comes down to a basic logical deduction: as borrowing costs rise, people borrow and spend less.
Otherwise, if the market believed that the Fed would go dovish in its policy, lending company stocks probably wouldn’t suffer such devastating losses in the back half of 2022. That’s one major clue that investors need to be cautious about cryptos.
Higher Energy Costs May Hurt Blockchain Enterprises
During the period of skyrocketing inflation throughout the post-pandemic new normal, it wasn’t just cryptos (prior to 2022) that saw meteoric gains. The once-deeply embattled energy firms benefitted from a surge in demand and relevance. Of course, higher energy costs negatively affect the profitability of crypto-mining enterprises, many of which are now publicly traded.
Here’s the dilemma. According to the U.S. Energy Information Administration, most of the electricity generated in the U.S. in 2020 stemmed from natural gas, nuclear energy and coal. This year, when Russia brazenly invaded its neighbor Ukraine, the artificially engineered (and thus unnecessary) military conflict spiked costs for energy resources, especially natural gas.
Of course, the solution that many blockchain enterprises have turned to is renewable energy sources. But even here, a significant challenge exists. Setting aside that wind and solar represent the least reliable major energy sources, going the renewable route trades one set of geopolitical dependencies for another.
If you look at the commodities that undergird renewable infrastructures, many of them are produced in large quantities by China and Russia. Until geopolitical relations heal, the renewable alternative might not be viable for crypto-related enterprises.
Virtual Currencies Have a Credibility Crisis
Finally, it’s impossible to talk about the risks that cryptos face in 2023 without mentioning the underlying industry’s gargantuan credibility crisis. Of course, the biggest controversy focuses on the implosion of FTX and its founder Sam Bankman-Fried (who’s often referred to as SBF). Once the darling of the virtual currency space, FTX and SBF have become the villains of what critics term the modern-day tulip mania.
While longstanding blockchain supporters often deride the Johnny-come-lately weak hands of the crypto market, the reality is that the blockchain ecosystem needs these weak hands. Otherwise, to whom would the strong hands dump their coins and tokens so they can buy homes and Lambos?
On a final note, CoinDesk.com reported in late June of last year that crypto miners faced margin calls and default risks. That was at a time when the total market cap for the sector was roughly near $900 billion. After losing about $100 billion in value, it’s doubtful that this circumstance improved for the better. Therefore, caution will probably be the key theme of 2023.
More Crypto News from Barchart
- Pick Your Asset: Silver, Oil, Tesla, or Bitcoin
- Cryptocurrencies Digest A Turbulent 2022
- Crypto Winter Continues
- Here’s One Hot Stock That Could Fundamentally Rise Even Higher
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes.
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