What happened
The crypto sell-off continued today, as investors continued to shun riskier assets amid high levels of inflation and the Federal Reserve's ongoing tightening of its monetary policy. The entire cryptocurrency market recently lost $200 billion in a single day.
Over the last 24 hours, the price of the world's largest cryptocurrency, Bitcoin (BTC 2.81%), traded down roughly 2.5% as of 12:57 p.m. ET. The price of Bitcoin is currently hovering below $30,000. The world's second-largest cryptocurrency, Ethereum (ETH 1.39%), had fallen more than 9%, with the price of one token now around $2,000. Finally, the meme token Dogecoin (DOGE 2.61%) traded about 5% lower.
So what
The Fed has now raised its overnight benchmark lending rate, the federal funds rate, by roughly 0.75% in just two meetings, including a full half-point move at its latest meeting. When interest rates rise, so do the yields on safer assets like U.S. Treasury bills, which are backed by the U.S. government. This leads investors to demand higher returns from riskier assets and turn away from riskier assets if they don't see a path to those higher returns.
Image source: Getty Images.
Additionally, the Fed has indicated that it will begin reducing its $9 trillion asset balance sheet and will eventually ramp up to running off $95 billion of bonds by September. This will effectively remove liquidity for the markets, which means there could be less money to support riskier assets and higher valuations. Although many believe Bitcoin could be a hedge for inflation given its finite supply of 21 million tokens, the thesis has not played out so far and Bitcoin has acted similarly to tech and growth stocks, taking an absolute beating this year. The price of Bitcoin is down close to 55% over the last six years, and some think more difficulties lie ahead.
"My chart picture is calling for a fall to the $17,000 region and Bitcoin would need to close above $33,000 to give pause for thought," said Oanda analyst Jeffrey Halley, according to Barron's.
Broader crypto concerns have also arisen due to issues with stablecoins, which are digital assets pegged to some kind of commodity or fiat currency. One of the more notable ones, TerraUSD (USTC 4.47%), which is pegged to the U.S. dollar and is therefore supposed to trade around $1, has seen its price plunge to below $0.30 per token, which is a huge red flag.
TerraUSD is an algorithmic stablecoin, meaning it is not actually backed by any real-world assets but uses complex technology, coding, and algorithms to maintain its price of around $1. TerraUSD's sister token, Terra (LUNC 2.22%), which is important for helping it maintain its peg to the dollar, has billions of reserves in Bitcoin.
"I think the market is expecting some forced selling [of Bitcoin] here on the part of Terra and the reserve," Nic Carter, co-founder of Coin Metrics, told CNBC earlier this week. "It is a calamity but very expected. No algorithmic stablecoin has ever succeeded and this is no exception."
Now what
Whether it's inflation, the Fed's unwinding of its balance sheet, or the chaos with TerraUSD and Terra, the crypto market is in a very precarious state right now and investors are rushing to safety.
While I have no idea how low the crypto market will go, I definitely expect Bitcoin and Ethereum to survive and be good long-term buys, given that these are the two most important cryptocurrencies and that crypto adoption continues to move forward.
I suspect Dogecoin will be around as well but have never seen it as a good investment and do not recommend it.
