Down by a jaw-dropping 58% in 2022, Bitcoin is in a bear market. The pressure probably won't ease anytime soon, either, with liquidity drying up in the economy and public confidence in crypto falling to unprecedented lows. That said, Bitcoin still looks like a long-term winner, and investors should start looking for the bottom of this current decline.
Bitcoin's performance correlates with that of mainstream financial markets
Far from an uncorrelated safe haven against the mainstream economy, Bitcoin has closely tracked financial markets like the NASDAQ Composite, which is down 30% year-to-date. The similar performance between these different asset classes suggests they are influenced by some of the same macroeconomic forces, like inflation and monetary policy.
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With the U.S. inflation rate hitting 8.6% in May, the Federal Reserve is taking a more hawkish stance -- trimming its balance sheet and increasing interest rates. This policy makes capital more expensive, reducing the amount of money available to invest in risky assets like stocks and Bitcoin. This trend has led to weakness in many financial markets that may continue until the Fed changes course, which probably won't happen until inflation falls to a manageable level. Bitcoin also faces some crypto-specific headwinds that will be challenging to navigate in the near term.
Trust in crypto seems to be eroding
As if the problems in the mainstream economy weren't bad enough, the cryptocurrency ecosystem is also facing a liquidity crisis of its own as altcoin valuations plummet. Once-popular assets like Shiba Inu and Terra Luna are down 89% and 99.9% from their all-time-highs. Altcoins are often traded through mainstream cryptocurrency pairs, so the disappearance of billions in paper wealth negatively impacts Bitcoin and the rest of the market.
Crypto also faces a confidence crisis as high volatility and low liquidity push some altcoin business models to the breaking point. In May, stablecoin platform Terra collapsed after losing its peg to the U.S. dollar. This month, the crypto lending platform Celsius froze user accounts because of its strained liquidity. These high-profile crises erode public trust in crypto, which is a near-term headwind for the industry.
The good news is that Bitcoin's relatively simple design (as a way to store and transmit value) protects it from many of the challenges faced by the newer and more complex blockchain projects. And over the long term, the current crisis could strengthen the industry by "shaking out" assets with weaker designs and highlighting the strengths of more resilient cryptocurrencies like Bitcoin.
Bitcoin is still a long-term buy -- but investors should be patient
Despite the current challenges, Bitcoin is still a long-term buy because of its advantages in scale and trust relative to other cryptocurrencies. But with sky-high inflation and the U.S. Federal Reserve at the beginning stages of a tightening cycle, it could be a while before we see the bottom of this current bear market.
Investors should probably wait until inflation cools down and U.S. authorities take a more dovish monetary policy stance before expecting a sustained recovery in Bitcoin's valuation.
