With global inflation reaching new highs month after month and the Federal Reserve and Central Banks adopting a more hawkish tone, the United States and the global economy are highly vulnerable to an approaching recession or possibly a stagflation.
If forecasters are true and the global economy faces another major recession as early as next year, the cryptocurrency markets and Bitcoin may see a wholly distinct outcome from one another.
What Does this Mean for Bitcoin and Cryptocurrency Markets?
Image source: QuoteInspector.com
Like never before, cryptocurrency markets are moving in lockstep with equities and bonds. According to Dow Jones Market Data, the three-month correlation between cryptocurrencies and major US stock indices reached its highest level last week.
A correlation of 1 indicates that the markets are moving in lockstep, whereas a correlation of 0 indicates that they are unrelated. According to IntoTheBlock, a market intelligence tool, the correlation levels between stock markets and crypto are now at historic highs of 0.9.
Image source: twitter.com/intotheblock
This is more than triple the average correlation between cryptocurrency and the SNP500 from 2019 to 2021.
This means that all macroeconomic headwinds that normally affect stock markets will have the same effect on all digital assets when investors sell in a falling market.
However, a distinction must be made between Bitcoin and the rest of the cryptocurrency sector.
A Different Kettle of Fish
Venture capital and institutional investors fund the majority of smart contract blockchains and many other cryptocurrency projects. These blockchains are developed and launched by registered companies (many offshore), all of which have marketing budgets, tokens assigned to teams and foundations, grant pools, head offices, founders, CEOs, CFOs, COOs and so on.
Image source: bloomberg.com
In essence, these are private software companies that build decentralized blockchains as their primary product/service, all while adhering to ESG corporate policies. Some are more successful than others, but the goal is the same: to provide a decentralized blockchain with smart contracts.
How Decentralized are They?
Even though some prominent smartchains are decentralized on the blockchain level, with a large number of widely distributed nodes, they are not decentralized in other ways.
A vast majority are not decentralized at the team/developer level, relying on a small number of individuals and institutions to develop and operate the blockchain. The case in point is Ethereum, whose development is largely centralized in accordance with the vision of its founder, Vitalik Buterin, who has the authority to direct the project to his liking (Ethereum’s “difficulty bomb” for example). Additionally, there is no community consensus process in place to approve protocol changes.
Furthermore, various centralization aspects can be apparent on an initial coin allocations; governance; or infrastructure level, such as relying on central organizations, like Infura or AWS’s cloud computing services to operate/interact with dApps or to store an entire transaction history.
One such event occurred in March last year with the non-custodial wallet provider MetaMask, which was meant to be decentralized.
Image source: metamask.zendesk.com
Investors and Bear Markets
In behavioural finance, a subfield of behavioural economics, investors show herd behaviour when investing, and investors have a bias towards risky assets in bear markets (Kjelldorff & Keskitalo, Stockholm School of Economics, Nov 2009).
As a result, during a bear market, institutions that support the majority of blockchain projects may significantly lower their funding/investments or abandon some projects entirely, which will have a significant impact on the crypto markets.
Image source: pwc.com
We witnessed a similar behaviour with internet stocks during the dot-com boom. Many investors were eager to invest in any dot-com startup, regardless of value. It was simple to attract venture capital, and investment banks, who gained handsomely from IPOs, fueled speculation and spurred technological investments. However, during the dot-com bust, institutional investors withdrew their money out, causing many firms to go bankrupt and others that did survive, such as Amazon and Cisco, to lose 80% of their market value.
Smart contract blockchains have yet to achieve a mainstream adoption. Similar to early tech stocks more innovation and development is needed across DeFi, blockchain gaming, metaverse, health on chain, move-to-earn, NFTs sectors to drive adoption and thus value across crypto markets. Hence, a rebound in crypto markets might be triggered as more use cases and new innovative applications are developed. If stagflation and economic crises are anything like the 1970s, this may take years.
It has to be noted that many of these smart contract blockchains have tremendous potential. An incredible amount of innovation has already been achieved, and perhaps over the long run, we will see a decoupling of crypto assets from the tech stocks, as crypto tokens mature and develop their own unique characteristics.
Bitcoin, on the other hand, is a different kettle of fish.
Bitcoin
Image source: flickr.com
Yes, Bitcoin, like other cryptos, is correlated to stock markets and it’s likely to experience heavy selling pressure, but we believe this will be transitory.
The Anna Karenina Principle
The Anna Karenina principle is based on the opening line of Leo Tolstoy’s ‘Anna Karenina’, “All happy families are all alike; each unhappy family is unhappy in its own way” is applied to financial markets.
Bull markets, in essence, appear to have a number of characteristics: everything flourishes, Central Banks are on board, sentiments are good, and money is flowing. In a bear market, however, each asset appears to be ‘unhappy’ in its own way.
Bitcoin will play by its own rules and, in our view, will recover faster. The rationale for this is simple: Bitcoin is a public commodity — a decentralized payment network powered by energy rather than human decision-making, where everybody can agree on its ledger and historical transaction data — a true democratization and decentralization of money.
Bitcoin — As The Payment Network
Bitcoin is the world’s most secure and fastest growing payment network. By the end of 2021, transaction volumes have grown by about 100% yearly over the last 5 years (G. Cipolaro, E. Kochav, NYDIG, Jan 2022):
Image source: NYDIG report (LinkedIn)
Humans have traded with one another for thousands of years and will continue to do so for thousands more. Money’s material form has changed dramatically over the last 10,000 years, from cattle and cowrie shells to today’s electronic currency. As long as humanity exists the trade will carry on, and Bitcoin is the fastest growing, alternative form of money, adopted as a legal tender in two nation states despite being just 13 years old.
The Lightning Network
Lightning Network is a payment protocol built on top of Bitcoin. It’s a decentralized system for instant, high-volume micropayments between users. It’s arguably the best tool to determine Bitcoin’s use case as a “payment network”, and how actively its being used to pay for real world goods and services, rather than just “trading”.
Bitcoin Lightning Network is growing rapidly, now more than 80 million users are estimated to have access to this network, compared with 100,000 in August 2021. According to Arcane Research, in the first two months of 2022, Lightning Network processed over a million payments with an approximate payment volume of $45 million, a 410% YoY growth.
The distribution of all of these payments are as follows:
Image source: Arcane Research Report 2022
We gain a better understanding of Lightning Network transactions by breaking them down. In the first two months of 2022, about half of total payment volume is exchanged directly between individuals. These payments can be used for a variety of purposes, including remittance payments to family overseas, borrowing or lending money to friends, purchasing items from neighbours, and so on.
20% of the payments have been purchases of goods or services handled through a payment processors or bought indirectly through gift cards.
Since the majority of Lightning Network transactions reflect payments of true economic value, such as paying for goods and services, Bitcoin’s use case as a payment network is reinforced.
Bitcoin Leads the Adoption
Bitcoin continues to capture the largest part of the crypto market, both in terms of market capitalization and the number of users.
According to Crypo.com report, as of 2022, around 176 million out of 295 million global crypto users, or just under 60%, own Bitcoin, whereas only around 23 million, or under 8%, own Ethereum.
Image source: crypto.com
Despite Bitcoin’s decline in market capitalization, indicated by the falling BTC dominance below 40% from November to December 2021, it did not affect the number of people owning Bitcoin.
New crypto users are adopting Bitcoin rather than Ethereum or any other cryptocurrency.
Image source: crypto.com
According to the report, in the second half of 2021, the number of Bitcoin users grew by 37.5%, increasing from 128 million in July to 176 million in December. Ethereum, on the other hand, saw the number of its users increase by only 1.4% during this period.
Even though smart contract blockchains, such as Ethereum, have showed substantial innovation with DeFi, games, NFTs, much more time is needed for a global adoption, whereas Bitcoin has a proven real world use case — a secure, trustworthy payment network used by millions of people worldwide.
Quality Over Quantity
Although smart contract blockchains like Solana and Ethereum have handled many more transactions than Bitcoin, the majority of these transactions are of little economic value.
For example, mining pools, which are collections of crypto mining systems, distribute fractions of cryptocurrencies amongst themselves, creating thousands of transactions on a blockchain. These have zero economic value. Another example is spam, which is a major contributor to rising transaction numbers. This is especially the case with Ethereum, which supports thousands of tokens on its blockchain. The Bloomberg report states that spam contributes 19% of all non-economic value for Ethereum.
According to Coinmetrics, 98% of Cardano’s overall transactions are worthless. Elementus Inc., another analytics company, found that 45% of transactions on Ethereum’s network consist of non-economic exchanges, such as spam. Coinmetrics deducted the number of non-economic transactions from Ethereum’s blockchain and came up with a true economic transaction volume of $700 million for Ethereum per day, or $255 Billion per year.
Compare this to Bitcoin’s true economic transaction volume of $3 Trillion per year. According to the research from NYDIG, Bitcoin processed $3.0T in payments in 2021, surpassing well-known card networks such as American Express ($1.3T) and Discover ($0.5T). To avoid misreporting such data, NYDIG report excluded transactions with no economic value.
Image source: NYDIG report (LinkedIn)
Given that Ethereum is the largest smart contracts blockchain, with the majority of DeFi and NFTs (according to defillama.com), it’s reasonable to assume that the other blockchains processed far less in true economic transaction volume than Ethereum.
Bitcoin — As The Store Of Value
Image source: Flickr.com
J.P. Morgan global market strategist Nikolaos Panigirtzoglou and his team believe Bitcoin might become an alternative to gold. Bitcoin, often described as the “digital gold,” possesses some of the same properties that have made gold one of history’s most important capital guardians: it’s difficult to mine, it’s scarce, durable and non-sovereign.
The total market cap of Bitcoin and gold may eventually equalize because they serve the same purpose, according to the investment bank’s strategist. However, because volatility is so important in institutional investors’ risk management, the market cap of Bitcoin held by institutions is unlikely to reach gold’s level until volatility subsides. Latest data indicate that this has already started to happen.
Image source: Bloomberg Finance
Bitcoin — As The Tool For Human Rights Activists
Furthermore, Bitcoin has been used on many occasions as a financial tool for human rights activists around the world. Roya Mahboob, a founder of the non-profit Digital Citizen Fund along with her sister, taught thousands of girls and women basic computer skills in their centres in Herat and Kabul. Women also wrote blogs and made videos for which they were paid in Bitcoin, as most girls and women didn’t have a bank account because they were not allowed to.
Or the story of Farida Nabourema, a human rights activist in Togo, who was protesting against Togo’s authoritarian regime for a democratic change, leading hundreds of thousands of people in the streets for first time in history and being met with massive repression. The donations sent by the supporters of Farida’s movement, which helped to organize the protests and to provide basic resources, were frozen by the Togo’s government. This led to them sending money to neighbouring nations and smuggling cash across the border to Togo until she discovered Bitcoin. This allowed to transfer money directly, with the totalitarian government of Togo unable to seize any of it.
Summary
As it appears that we are on the cusp of a global recession, as forecasted by multiple prominent organisations such as the IMF, Goldman Sachs, and Deutsche Bank, all markets will be affected. Investors will be seeking for safe havens, and the best will naturally survive.
It’s important to understand that crypto and Bitcoin are not the same thing. Smart contract blockchains are here to stay due to their incredible amount of innovation and creation of new market opportunities. Bitcoin will likely deviate and forge its own path. The key property of Bitcoin is that it’s truly decentralized — its the only one medium of exchange that doesn’t require you to trust someone, which is a major breakthrough in today’s imperfect world.
DISCLAIMER: The information contained in this article is for educational purposes only and does not constitute any form of advice or recommendation by Wheatstones, and is not intended to be relied upon by users in making (or refraining from making) any investment decisions.