Why did the cryptocurrency market decline this week?

Cause of the crypto market drop this week?

Author: MARCEL PECHMAN, COINTELEGRAPH; Translation: Song Xue, LianGuai

The cryptocurrency market has recently experienced a noticeable downturn, with a total market capitalization drop of 10% from August 14th to August 23rd, reaching the lowest point in over two months at $1.04 trillion. This trend has triggered a large-scale liquidation of futures contracts, marking the largest liquidation since the FTX crash in November 2022.

Cryptocurrency total market capitalization, in USD. Source: TradingView

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Several economic factors have contributed to this decline. Due to interest rates surpassing the 5% mark while inflation remains above the 2% target, borrowing costs for households and businesses have increased, putting pressure on consumer spending and economic expansion. This means that funds available for savings have decreased, potentially forcing people to forego investments to pay monthly bills.

With inflation expectations for 2024 at 3.6% and average hourly earnings growing at a year-on-year rate of 5.5%, the fastest pace since 2020, the Federal Reserve may maintain or even raise interest rates in the coming months. Therefore, a high-interest rate scenario favors fixed-income investments, which is detrimental to cryptocurrencies.

The inflation rate has fallen from its peak of 9% to the current 3%, while the S&P 500 index is only 9% below its all-time high. This may indicate a carefully planned “soft landing” by the Federal Reserve, suggesting that the possibility of a long-term and severe recession is diminishing, temporarily weakening the investment theory of Bitcoin as a hedge tool.

Factors emerging in the cryptocurrency industry

Investors have high expectations for the approval of spot Bitcoin exchange-traded funds (ETFs), particularly with the heavyweight endorsements of BlackRock and Fidelity. However, these hopes have been dashed as the U.S. Securities and Exchange Commission (SEC) continues to defer its decision due to concerns about inadequate measures to prevent manipulation. Complicating matters further, a significant amount of trading using stablecoins continues on unregulated offshore exchanges, raising questions about the authenticity of market activity.

Tightening regulations further exacerbate the market’s difficulties. The U.S. Securities and Exchange Commission (SEC) has brought a series of charges against Binance and its CEO, Changpeng Zhao (CZ), accusing them of misleading conduct and operating an unregistered exchange. Similarly, Coinbase is also facing regulatory scrutiny and lawsuits regarding the classification of certain cryptocurrencies as securities, highlighting the ambiguity of U.S. securities policies.

Despite the global economic slowdown, the U.S. dollar remains strong.

Economists have lowered their growth forecasts for China, as imports and exports have declined in recent months. In the second quarter, foreign direct investment in China fell more than 80% compared to the previous year. Of concern is the outstanding bill of Chinese private developers, which amounts to over $390 billion and poses a significant threat to the economy.

Despite the deteriorating global economic outlook, the scarcity of Bitcoin and its fixed monetary policy may enhance its attractiveness. However, investors still show a tendency to flock to the perceived safety of the US dollar. This is reflected in the performance of the US Dollar Index (DXY), which has surged from a low of 99.5 on July 17th to its current level of 103.8, reaching the highest point in over two months.

US Dollar Index (DXY). Source: TradingView

As the cryptocurrency market grapples with these multifaceted challenges, various economic factors and regulatory developments will undoubtedly continue to influence its trajectory in the coming months.

This situation may be an over-optimistic result of multiple spot Bitcoin ETF applications submitted in mid-June. Therefore, instead of focusing on the reasons for the recent 10% pullback, it is more appropriate to question whether the mid-July rebound was a result of the 10% pullback. A market capitalization of $1 trillion reaching $1.18 trillion is reasonable.

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