After a bull market, in March, cryptocurrencies plummeted all together with the stock markets. Will the recession bring the crypto crash?
As it seems, 2020 is an eventful year. We started with the fires in Australia, then the fear of World War III, and on top of that, now we’ve got a pandemic. Even more, a recession will most likely follow in the coming months.
However, the market expected Bitcoin to be a safe haven for investors. But the enormous volatility seems to say otherwise. And as we will see, what is a safe haven for investors might change drastically.
So let’s dive in and see what is going on with Bitcoin, cryptocurrencies, and the financial crisis.
What is a financial crisis?
To understand how it affects Bitcoin, let’s first understand what is a financial crisis and how it leads to a recession.
The financial crisis can be understood as a quick event that creates great instability in the market. Events like a bubble burst or a sudden drop in the stock market can affect drastically how business relations work.
And because the industries are interconnected, a financial crisis can lead to recession due to a snowball effect in which payments are interrupted between parties. And when a company doesn’t get its money it can’t give money to anyone else.
Because it is a period of economic uncertainty, during a financial crisis business failure happens more often and the stock markets tend to fall.
The term recession refers to an interval in the business cycle where most of the economic activity follows a downturn trend. The economy’s contraction typically comes with declines in Gross Domestic Product (GDP), unemployment rates going up, and consumer confidence going down.
Normally, a country may declare a recession when the GDP is in negative growth for two consecutive quarters. There are also exceptions in which a government could declare recession based on other economic indicators like monthly GDP data, especially if things deteriorate quickly.
Once it starts, a recession situation may last for as long as it takes for the markets to adjust, and it can mean anywhere between a quarter and several years.
When it comes to causes, there are a lot of factors that can lead to a general decline in the economy. A few of them are:
- Overconfidence in a market
- The fake success of a market
- Borrowing loans that cannot be paid
- A break in the supply chain
- A break between buying and paying
- A calamity
- A pandemic
Basically, with such a massively interconnected financial system we have today, anything that disrupts the typical course of our global economy can lead to a recession.
The 2008 Recession
The most recent recession the world saw was The Great Recession from 2008, when the financial system almost collapsed due to the housing bubble.
In a period of liquidity flooding the market and easy credit, banks gave out loans for houses to unqualified borrowers. This ultimately led to drastic increases in price.
Because the real estate market performed so well, investors started investing massively in mortgage-backed securities. Moreso, banks repackaged the loans as collateralized debt obligations. When the interest rates started rising, many subprime borrowers could not afford the higher rates and started defaulting.
SIDENOTE. Collateralized Debt Obligations – a financial product backed by a pool of loans sold to investment banks, then repackaged to be sold to investors.
SIDENOTE. Defaulting – the event in which a debtor fails to make an agreed-upon payment to his creditor at the agreed-upon time.
The real problem was that financial firms and hedge funds owned more than 1 trillion dollars in securities backed by failing subprime mortgages. This situation led to more and more companies filing for bankruptcy. And with every big corporation going bankrupt, this translated into a lot of people losing their jobs.
With the unemployment rate going up, consumer confidence kept going down which only made the situation worse.
To prevent a financial catastrophe, governments around the world started buying distressed assets, including mortgage-backed securities.
Are we headed for a recession?
Economists and market analysts have been expecting another recession since 2017. In 2019 it was almost sure that the collapse of the bonds market will be the financial crisis that brings the recession.
That did not happen. However, an unforeseen pandemic in 2020 sent the world into quarantine and shut down the economic activity. And this seems to be the trigger.
The current situation may have hit hospitality and travel companies the hardest. But by looking at the Dow Jones Industrial Average, FTSE 100 index, and S&P 500 Index we can see the general contraction of the economy.
Source: Hargreaves Lansdown
Source: Yahoo Finances
All stock markets are down, supply chains are stalled, economic activities are either interrupted or reduced, and employees are not able to work normally. It sounds like the recession is on its way.
Panic sell-off and the demand for cash
In times of economic distress, financial advisors recommend keeping your money into securities like bonds, gold, and silver. Furthermore, gold historically increased its value during recessions, but the Coronavirus seems to throw it down too.
Why? Because people want cash.
Due to unprecedented circumstances, the world is reduced to a state where people only seek physiological and safety needs. Investing in stocks, securities, or anything else is not a priority.
The sudden high demand for liquidity caused massive sell-offs which in some cases can’t even be supported all at once.
Be it stocks, treasury bonds, gold, or even cryptocurrency, they value nothing when compared to toilet paper.
Crypto crash? Shouldn’t Bitcoin be resistant to recession?
Bitcoin emerged after the 2008 financial crisis due to the distrust in the centralized financial system. It started the cryptocurrency revolution which seeks to create a trustless decentralized financial system in which everything is guaranteed by code.
Because there is a fixed amount of Bitcoins, inflation doesn’t apply. Furthermore, it is considered the digital alternative for gold, as a store of value. So falling from almost $10,000 to almost $5,000 can certainly make a hodler question his assets.
At the end of the day, all cryptocurrencies are based on a community’s belief that it’s worth something. Which in a way, is not that different from Fiat currencies.
But the crypto market is known for its huge volatility. and such a drop doesn’t mean a crypto crash.
Bitcoin and altcoins recovered from far worse and if you still have this question in your mind “will crypto bounce back?”, go on CoinMarketCap and see they already did.
Worst case scenario for Cryptocurrencies
The fear that the crypto market will hit the floor and lose all value is not new. The doomsday prophets play this crypto crash card to grab media attention every time the market goes down.
However, there is a reality behind all that fear. Unfortunately, there are a few players in the market that have the resources to manipulate the price however they want. In the crypto community, they are called whales.
If the whales decide they want to crash the Bitcoin once and for all, they do have the ability to do so. If they start selling off and all hodlers lose faith and sell their assets for fiat as well, the prices could go down to unprecedented levels.
And if the prices go down too much, the miners are going to give up the network, because the power consumption to generate the hashing power will cost too much to be sustainable.
This means cryptocurrencies with proof of work blockchains will lose speed and security.
Yet, the crypto crash still might not happen. Cryptocurrencies that use proof of stake and other consensus algorithms that require less electricity may recover even from such an event.
Anyhow, a pandemic such as Coronavirus could bring the cryptocurrencies to an end. How? Well, if society collapses, and the internet stops working, everything in the digital world will be gone.
But I guess it won’t matter anymore when the world goes Mad Max.
Best case scenario
Cryptocurrencies indeed lost 30-50% of their value in less than a few days. It’s their bad habit to keep acting like that.
The massive selloffs in all markets and the halt on the business world is taking a toll on the economy. But Bitcoin is not a company and cannot go bankrupt and disappear. And when the Bitcoin gains trust, all the crypto market gains trust.
In the best-case scenario for the crypto market, due to the financial crisis, more and more people will find Bitcoin and altcoins as appropriate stores of value. The demand will rise and so will the prices.
Quantitative easing announced and the Interest in Bitcoin skyrockets
To ease the financial distress caused by the pandemic, on March 15, the US government announced that the Federal Reserve cuts rates to zero and launches a massive $700 billion quantitative easing program. Several governments around the world announced similar policies as well.
Although it might ameliorate the recession it will follow, such a global quantitative easing will most likely translate in further devaluation for cash due to inflation.
Contrary to the high demand, actually holding large amounts of cash may soon prove to be a bad idea.
Curiously, after the announcements of rate cuts and quantitative easing, the interest in the “bitcoin” and “recession” search terms seems to have skyrocketed, as shown by Google Trends.
Bitcoin is considered by many to be the “digital gold” and is expected to hold its value well through the recession. However, Coronavirus caused a global sell-off that affected even the crypto market. Although cryptocurrencies suffered a downturn all together with traditional markets, the crypto crash is not coming. Moreso, the crypto market seems to be slowly recovering.
Furthermore, the fear of recession, the quantitative easing, and the rate cuts seem to spark the interest for Bitcoin back to the levels of Summer 2019 when the price reached $12,000.
Within this socio-economic situation, the Bitcoin halving event and the launch of Ethereum 2.0 may bring more energy into the market that the community ever saw.
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