Is Bitcoin back? Exploring the Future of the Crypto Market in 2023

Digital assets have had one of their worst years on record in 2022 with many negative events contributing to their downfall. The recent rally in Bitcoin and Ethereum is making investors wonder if the asset class has become investable again, and whether its correlation to traditional risk assets will mirror 2022's.

Bitcoin and crypto assets saw their fair share of scandals and exchange bankruptcies in 2022. Crypto exchanges that were supposedly well capitalized in the months leading up to their demise suddenly found themselves over-levered in the face of aggressive rate hikes in most developed nations.

Three Arrows Capital and Celsius Network were some of the first dominos to fall in the crypto carnage of 2022 when bets on Terra Luna wiped out close to 50 billion dollars in value for their investors. The Regulatory and risk management failures of these two companies should have been the canary and the coal mine for what became the most sensational and unexpected wipeout of 2022: the implosion of FTX.

Although the total value lost from the FTX collapse was lower than that of Three Arrows Capital, 32 billion USD versus 42 billion USD, the reputational damage to crypto exchanges and the asset class as a whole was far worse as a result of the celebrity endorsements and Pension Plans associated with FTX. This led many investors, sophisticated or otherwise, to ask a very obvious question: can this asset class and the companies operating within it be trusted?

Only time will be able to answer this question, and it is important to know that bad actors exist in all Industries can affect all asset classes. What is perhaps more important, is to focus on the fundamentals which saw crypto's initial rallies over the years, and to judge whether the current and future environment will provide a similar opportunity for investors.

Although past performance is not indicative of future results, sophisticated investors know that history is often repeated. Fundamental and economic factors which led to the popularity of crypto as an asset class can continue to provide support to cryptocurrencies despite the volatility that should be expected from such a new asset.

There is no doubt that quantitative easing and relaxed monetary policy were major contributors to the breathtaking rally that cryptocurrencies across the board saw in 2020 and 2021. There is also little indication that we will be returning to an easy money environment anytime soon. The charts below show the relationship between Bitcoin prices and prevailing interest rates over the last three years:

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Figure 1: Bitcoin Price (last 3 Years)

Figure 2: Ethereum Price (last 3 Years)

Figure 3: 2-Year Treasury Rate (last 3 Years)

Though the graphs are not overlaid one can easily see that the period between July 2020 and January 2022 is characterized by near-zero interest rates and a steep incline in the price of Bitcoin and Ethereum. Similarly starting in January 2022, we notice a peak in the price of crypto assets and a rapidly increasing 2-year treasury rate. It should come as no surprise that risk assets drop in value as interest rates move up as was clearly seen in the tech heavy NASDAQ but also the S&P 500 which has recently become fairly Tech heavy as well.