• Jan

Crypto outlook and why upside might be capped for the next two years



After the bull cycle deflates there is a prolonged period of bear market



Without going too in-depth into fundamentals, we can use technicals and the Bitcoin/Altcoin flows to see historically what has happened in each case after the bull cycle topped out. Using that we can establish the top of the market in November 2021, and we are not even a year out after the top was created. This means the likelihood of a further year or two of the dry and cold market within crypto, in general, is likely to come, using this simple previous bull-bear cycle time ratios. And that was to be the case if global market conditions were perfect, which they are rather far from that. All of this means that if prior bear cycles lasted on average X time length and this is used as a guide again for projection, it's possible that this time might be extended rather than vice versa. More about that on the article lower.


From a personal view, this is a robust variable suggesting that for next year it is best not to set any significant bullish expectations within crypto, but more specifically especially not altcoins. While Bitcoin might surprise with some smaller bull cycles in between, it is much more unlikely for that to be the case in altcoins, as per historical projections.

To expand on that further, the chances of a bull cycle in crypto next year are low due to the bear cycle not lasting long enough yet (historical reference) and the challenging macro environment, however, Bitcoins' chances to hold range are still better than altcoins, as per the context. This is key because many are already rushing into altcoins within this dip seen over the past three months.



If equities go further down (dividend-driven asset) the crypto has even more chances for lower moves (no yield or dividend)


In the current environment where bond yields in all markets started to surge, and yields on everything began to rally, the market will by default seek higher-yielding low-risk assets (inflows) to park more capital in and pull out of 0 dividend or no-yielding assets (outflows). This at least for institutional investors creates fewer reasons to put long-term value into Bitcoin (and especially altcoins) and rather park it in similar lower-to-medium-risk assets that have at least some yield delivery such as long term bonds. It is not all-it reason, but it does contribute some, especially if interest rates remain high and the bonds keep sucking the capital on the US side while leaving risk-on assets dried out due to yield difference. The hiking cycle of FED did its damage to crypto assets no doubt, keep FEDs policy in mind to form a good view for the near future, using the interest rates and tight/loose monetary policy will be important contributors to price performance, crypto, after all, is not just about technology drive and adaption, especially if the market gets very speculative stretched.


If interest rates remain high for the upcoming two years then the chances for crypto to perform well are reduced. And FED officials have signaled that they will keep rates high, and not repeat the tightening/loosening cycles of interest rates that were deployed in the 1970s inflationary crisis, but rather keep rates elevated for a while, but obviously at lower levels than seen in the 70s due to higher debt levels. Whether they will keep the word is yet to be seen, but that is the narrative so far.


This means the market will for now at least until the end of the year 2022 price in elevated interest rates, and most likely at the start of next year as well, keeping crypto and equity markets under downward pressure. Some argue however that the flip side might be, "if the economy enters recession the FED will be forced into cutting rates, hence helping the asset prices at some point." Well think again, do you think the recession will help asset prices, even if FED starts to cut interest rates? The effects are likely to be negated, hence no relief is most likely. Risk-on assets need an economy within a somewhat non-contractive demand posture to perform well.


On image below is 2Y bond yields rally over the past year, to highlight the risk flows and shift from equities into bonds and less risky assets or especially yield-driven assets. The faster the yield moves to the upside, the more attractive it quickly becomes, putting more pressure on outflows from equities and crypto. As picture highlights we are witnessing one of the quickest yield (risk off) rallies in modern history, which obviously is quite destructive to risk-on markets.


But the point being is this if bonds are safest in the current environment of the upcoming few years, then stocks are second, because while riskier, there at least is a dividend payout and revenue to that as well from major corporations. None of which is present with Bitcoin (lack of revenue and yield), the risk is much greater to institutions because the asset is less tested and more unknown on what to expect out of it, this combined with no yield or dividend makes it less shiny in an inflationary environment. Being an inflation hedge might not be good enough. It might be for the retailer, but not for institutional capital, and since institutions are major order flow contributors one should not ignore it as it matters significantly for defining price direction or possibilities.


To highlight why large institutions might avoid crypto in the inflationary environment to some extent, even if Bitcoin is seen as an inflation hedge:


-not enough history on delivery in an inflationary crisis environment (young asset)


-no revenues from a large portion of crypto companies (young startups) poses hard to establish long-term value, especially if too speculative inflated valuations are present


-no yield which could make it less attractive against bonds in an inflationary environment because a decent % yield can outperform the inflation hedge % of Bitcoin or at least match it 1:1


-in short, it makes it less competitive asset against both the bonds and equities due to lack of above qualities


Those are not necessarily my own high-priority beliefs but certainly are some of the constructive arguments that larger institutions use to make decisions on why perhaps not to hold capital in crypto currently. And regardless of what I or you the reader think, their actions do matter and impact the price.



Emerging markets vs the US for long-term investment in crypto




Overall I still believe Bitcoin will probably get bid within emerging markets in upcoming years, and since in many of those countries crypto is not as established yet, the inflows might be stronger than outflows for crypto. However that might not be the case within the US, and since the US has the strongest capital markets, that creates quite a challenging view that might be contradictory. On one hand countries with crypto inflows and young crypto presence (emerging markets) and potentially big markets such as the US with outflows. Plus minus. This is especially the case because the US has seen major inflows in 2020 and 21 so the chances for outflows are higher than the inflows and this is what has already been the case over the past several months. More about that on article lower on how current environment might lead to selling of crypto at low prices still.


Especially because in emerging markets the need to hedge against inflation will be far stronger than in US (as it typically is in global inflationary environment), it might justify why emerging markets will have better performance of Bitcoin on long run versus the US (if measured in national currencies).


Understanding this is important for investors, not so much for traders who mostly trade in USD-denominated crypto, but investors who buy and sell every so often within their non-USD-denominated national currencies. If those currencies weaken in upcoming years due to inflation, and if inflows in crypto (in emerging markets) remain somewhat alright it is likely to see Bitcoin perform well in such countries, as long as we aren't talking about USD-denominated crypto prices. This is key to establishing good long-term investments in my view. Being long Bitcoin in emerging markets has been something I have recommended for the entire 2021, 2022 and will still be the case in 2023. The reason is as follows:


While we will see a significant worsening of economic conditions in many of those nations, inflation will be running hot in many of those countries (much higher than the US), which means once negatives are balanced against positives, actually the need to hedge against inflation in those countries will be significantly stronger than the outflows of liquidating crypto in those internal markets in my view. Which can help explain why Bitcoin has been doing good against many of those currencies and is likely to continue in the upcoming 1-2 years, even if in USD terms it is completely flat or even negative (BTCUSD). Therefore no rush to sell BTC in any non-USD currencies, unless one is forced to do so due to the low cash situation, at least from my view.


Summary: The need to hedge against inflation in many nations around the globe will be stronger than within the US, due to structural weaker positions of many countries (lack of food, energy and capital access), increasing the need for inflation hedge assets such as gold and Bitcoin, therefore the performance of Bitcoin in national currency prices might do okay in many of those countries, even if the economic recession is present.

It is less likely for that to happen within US and USD-denominated Bitcoin because inflation hedging might be lesser (more credit-driven economy as well), and the dollar might strengthen which will cap the potential for good performance of Bitcoin (due to global inflows into dollar debt), and other reasons.

Hence for next 1-2 years long BTC-(emerging or G8 market currency) but no long on BTC-USD.


Uncharted waters (high global inflation)


All past cycles of crypto were within the global deflationary environment. Some evidence is that inflationary regional economies (South America for example) do get inflows into crypto when the global environment is within deflation as proof of concept that Bitcoin can perform well in an inflationary environment, it is still important to keep note, that this was all meanwhile majority of the global economy was within the deflationary environment. And because crypto trades globally on daily basis, it does contribute to a skewed picture. Therefore the key question to ask is, can crypto perform well in a global inflationary environment where we dont have significant proof of concept from the past as clear answer?


The current macro situation has not yet been tested on crypto in the past, meaning we do not yet have evidence on what happens to crypto on a global basis (especially USD denominated) in an inflationary environment. Or let me put it in different wording, what happens to USD-denominated crypto markets in a macro environment where the USD is rallying strongly against all global currencies including crypto (as seen recently)? Those are significant downsides and untested waters for a bullish thesis on the crypto side, it cannot be ignored. However it is also true of course that dollar cannot rally forever.


And while some might assume "this is just the beginning of fiat collapse where all capital will go into Bitcoin", that is most likely a long-shot dream. Nor is Bitcoins recent performance signaling that to be happening at all as we have actually see both major FX selloff combined with the crypto selloff, and the dollar standing on the other side as an exception.



When using past inflationary crises as references and what was happening to Bitcoin inflows (Venezuela, Argentina, Russia, etc) keep in mind that those were all isolated inflationary examples. What we are talking about here is global inflationary crisis with a crunch on market liquidity everywhere. It is not necessarily completely different, it is just different enough and capital inflows into USD might significantly outweigh the Bitcoin inflows, especially if one is performing much better vs the other, hence changing the dynamics of where the capital goes. This is not to say that Bitcoin cannot perform alright alongside dollar in near future, it is only to establish the case that it will have more obstacles than usual to do so.



Central bank monetary policies of tightening and impact on crypto




Why gold sold off once FED began the hiking cycle explains why the yield is needed in an inflationary environment IF central banks hike interest rates. If there is no fight against inflation from central banks, inflation hedge assets can get bid as was seen with the gold risk environment in 2021-22, but once hiking began the assets began to sell off. If such an environment of high-interest rates was to persist (which so far seems likely from the FEDs comments), it is unlikely to see gold perform very strongly against the USD (however against other currencies it still can because of inflationary pressures in other economies are much greater). Some of that argument is shared to crypto as well, or Bitcoin especially as it shares some of golds asset values.


The point above is important to establish, because while it's clear why equities might be performing problematic in an inflationary environment that started this year (2022), it doesn't explain the poor performance on gold, as that needs to be highlighted through the shift in monetary policy. All of which is shared between crypto and gold to some extent, not fully of course.


To highlight the point of this more, let's use a basic outline and support that with some recent examples.


Generally, when central banks tighten policy and being to hike interest rates, the market will start to seek yielding assets (low to medium risk), especially if inflation is running high. If inflation is not running high (2015-18 hiking cycle by FED) then that is not necessarily the case, and we have seen crypto perform well in that tightening cycle of the past. Equities in that market also performed great.

Equities in the early stages of the last 2015-18 FED hiking cycle along with crypto were doing just fine:


When inflation is running high and central banks tighten aggressively (unlike slow hiking in the 2015-18 cycle) that is a very different story. The market will react much harsher against risk on assets and sell those. This is why we have seen a harsh response in 2022 so far in broad risk-on assets such as crypto and equities.



This means that it isn't just FED hiking cycle that establishes the direction of risk-on assets such as equities or crypto, but its the:


-speed of tightening,


-the levels of inflation,


-prior speculative vs under-priced levels of assets (was there a bubble or not)


-and global economic conditions


All of which as a whole contribute to the formation of price direction.


Additionally, we can use gold as another inflation hedge asset similar to Bitcoin to explain the process. In 2018-21 when geopolitical escalation (US-China) and trade uncertainty along with higher future inflation signaling began, the gold started to rally. The interest rates were still very low, and especially when they hit the bottom in 2020, the market will go into inflation hedge assets if central banks provide no fight against inflation by not raising interest rates (even if only mild 3% inflation), and the market will seek shelter in assets like gold or Bitcoin to some extent.


Gold chart on image below:



When 2022 began, and central banks started to tighten monetary policy the gold started to the selloff. Even though there were plenty of bullish variables working in favor of gold it wasn't enough. Those being strong geopolitical escalation (Russia-EU) and a high inflationary environment which both are typical conditions where gold performs well, it wasn't able to do so, due to tightening monetary policy and overall liquidation of assets across the board everywhere. This explains just how much weight this is carrying to define the future path of those inflation hedge assets at least on a short and mid-term basis.


The reason why highlighting gold is important within the image of thesis for crypto is, for those who use the reason of Bitcoin being an inflationary hedge as the strongest reason to perform well, we can see historically more established inflation hedge asset and safer in eyes of many-gold doing already poorly this year. This provides more insight that leaning too much reason for upside on Bitcoins price from an inflation hedge perspective is not a good idea if even gold is struggling, however, this all applies mostly to the US denominated gold and Bitcoin. As mentioned above in the article, for other markets the story is not the same. It is exactly because of the deteriorating FX exchange rates in other global markets against the USD why actually gold and Bitcoin both might perform alright in many other markets.


High correlation to equities



Within the entire 2021 and 2022, we have seen a high correlation being established between equities and crypto. The low-interest rate environment has driven both markets to the upside but has well-increased market capitalization and institutionalization of crypto space by a large degree, which explains why crypto "has caught up" in correlation to equity behavior and performance. That correlation has not decreased at all now that crypto has deflated in mid-2022, which means that it is likely to remain at those levels in foreseeable future.


It is as well important to keep historical references somewhat separated from the current context due to changes in conditions. Reasons why the correlation of crypto to equities has increased over the past two years are partially due to:


-increased market cap size


-increased liquidity and quicker pricing ability to other risk-on assets


-as the sector grew so did revenues of some crypto companies reflecting more equities similarities combined with inflation hedge abilities


Due to the above, it makes more sense to use 2020-22 data as correlation projections for the future (2023-25) rather than using 2015-2020 crypto to equity correlation flows because the difference and young age of crypto markets had too much difference still to equities. This correlation is therefore more likely to stay, rather than disappear and revert to the old 2015 environment for example at least from my view.

The reason why the above matters, is it gives one overview of what criteria to look for to establish the bull thesis for crypto. The reasons for both of those markets should be quite similar by now. It is too often seen that many participants are completely disconnected between those two markets (crypto investors have no interest in stocks, and have often low macro knowledge), which is not how one should approach crypto in the upcoming two years. While it is acceptable to be more ignorant in the very strong bull cycle (in earlier stages) that no longer is the case in a neutral or bear market, especially not if the market became a lot more equities correlated.

Whatever the justifications for long or short side on equities should somehow reflect into crypto as well. Not necessarily completely but if one has a completely disconnected view between each market asset class's directions then something is most likely off. As much as anyone would dislike reading that, because most crypto guys enjoy being outlaws of markets, that is the reality, connecting in the mid road of both is needed.

Chances for Bitcoin to do somewhat alright are low, but still significantly higher than any other altcoin



As with any prior crypto cycles or typical risk on/off flows the market will always prioritize the flows of riskiest and less risky assets within the asset class and go for less risky ones when conditions get tough. And vice versa.


Consider two facts. In prior cycles when altcoins started to rally on a broad basis, Bitcoin was always front-running that bull cycle. So anticipating altcoins to rally without seeing Bitcoin doing it first is not a high probability scenario.

As well as prior cycles, it took at least 2 years after the top before altcoins started to attract good activity again. And that was back when cycles were shorter in duration, which means this time one can add at least 1.5X to that. No longer being 2 years, but more likely 3 years, especially considering the macro environment has shifted into harsher conditions.


This equation suggests if one was to be exposed anywhere it's better to be in Bitcoin than most other altcoins for at least another year. Bitcoin is still more likely to outperform, and alts might struggle more. This is at least likely to be for entire next year, and then within two years the story might start to inverse once more where altcoins slowly start to begin more attractive (considering we haven't rallied much by then yet).


Inflationary conditions and tightening of free-cash-on-hand can result in further crypto liquidations at low prices (unlike any past cycles)



It is important to keep in mind that, while history gives us plenty of references and examples to lean on, it is even more important to understand when certain conditions between historical events replicate, the conditions present have to match and be similar to historical ones, if they were to replicate with similar results. It is no point in comparing prior situations to current ones if conditions are significantly different when it comes to building similar expectations.


In the past when the crypto market deflated, typically after initial leveraged liquidity gets shaken out, most of the other holders remained and were unshaken. The activity in forums, communities, and Youtube dried out, but the selling pressures also reduced and those that were in for the long term stayed. They went into hibernation mode. There were no significant recessions or a real worsening of global market conditions present in any of those situations, so it isn't surprising that on a large scale basis, people were less likely to get shaken out of positions once the market already has sold off significantly. If the market isn't highly leveraged and people arent forced to sell, after a prolonged selloff of the market, the selling pressure will calm down. That is what happened in past two major bull cycles that i have been around in crypto space.


Now switch forward to the current situation where global inflation is rising, and geopolitics is escalating everywhere around the globe, worsening market liquidity as well is something we experience on a global basis.

In such a tough situation, there might be significant further selling pressure on prices even while they are low because to increase cash reserves people across the globe might be more inclined to sell their crypto holdings. While it is true that the inflation hedge of Bitcoin is inflow property that goes against the selling flows at low prices while the need for cash-on-hand increases in inflationary environment, it is hard to justify that the first one can outbalance the second, if the economic situation was to get significantly worse, which considering what is in play it just might (elevated inflation, low GDP growth for 2023-24).


Therefore for the first time, we have significant reasons for selling pressure to keep going even at low prices of crypto over the upcoming two years, if the economic situation and inflation does not improve, but most importantly if central banks remain on rate tightening path.


Surprise QE and rate cuts (to play devils advocate to above thesis)



Something that could certainly inverse what was said above on the article would be the delivery of new large QE from FED and other major G8 central banks along with interest rate cuts if markets were to be swiped with a fresh influx of liquidity. This would ease the conditions and open up more risk-on capital flows and possibly create more of the environment that was present in 2020, obviously not to the same extent, but at least with some similarities. This would be bullish no doubt and could send prices rallying in crypto.


From my view, we might see such QE policies implemented in plenty G8 nations especially debt-driven QE purchases (bonds) but perhaps to some extent as well more inflationary cash handouts and M0 monetary supply extension all meanwhile the interest rates remain high to fight the inflation. The question is, how big would those QEs be, will they offset the damage from high-interest rates, and how impactful will they be to equity and crypto markets in general. This remains to be seen.


There are two different components within it. One is rate cuts if economic activity starts to turn south with unemployment increasing in the next two years due to issues we are facing, which would be crypto bullish. And the other is QE implementation to ease conditions in the market, which as well would be crypto bullish. Either of those implemented is bullish, but both are much more. What is the likelihood of this happening? Based on all said above, it isn't very high and actual impact might be mixed, because positive effects would be dampened by the recession if that was to happen. Some pluses and some minuses, and the size of QE or direction of it would at the end determine if it is truly bullish or just how long it might last.


Betting on this to happen as high probability and placing positions with high exposure is a no-no in my view. If it was to happen there is no need to pre-position in low probability trade, since if announced as surprise markets would be unable to price it in ahead correctly and would still provide a good enough opportunity after confirmation. In my view, this is the safest and highest probability way to play it, rather than go along, pray the central banks change their mind next year and get a payout on position. But to be firm on the point, if there is anything that can be the most short-term bullish to crypto or equity prices it is probably large-scale global coordinated QE delivery. Something i have observed trough last bull cycle in crypto is that very few understood just how important that global QE liquidity was to support the large rally in crypto of 2020-21 run.


Conclusion


My conclusions are as follows for next 1-2 years:


-we will likely see Bitcoin outperform many global currencies, due to inflationary conditions


-we will see Bitcoin outperform altcoins still for the entire 2023 (have already written about that in a previous crypto article)


-we will not see Bitcoin outperform the USD in the next 2 years

or at least not strongly


-we might see equities perform better than crypto in US markets but not in other smaller emerging equity markets


-we will see selling flows and bearishness on crypto to remain present for at least one or even two more years on a global basis, with no ignition of NFT frenzy stories any time soon or anything new along those lines


-we will see Bitcoin being capped under 35k in USD terms for next entire year likely

As someone engaged in crypto markets since 2012 let me be upfront that this isn't an article on the topic of "crypto is done so forget about it". This is about defining a better chance of timing when to start dollar cost averaging or when to start investing, or especially when to start trading for a potential large-scale bull rally.


Next year, unless something unexpected happens in central banks policy, the chances are just not great and favor upside to be capped. There will be time to go long, it's just not there yet. The retail sentiment is typically very much rushing after an initial dip in the market because everyone just wants to deploy capital as fast as possible anticipating the bottom to be in and the market to rotate, but in crypto typically that's not how it went in the past. First, all those eager buyers get taken into a prolonged period of drawdown after buying in too early first dip, and then everyone loses interest after crypto is dragging for 3 years, and only then the big bull cycle begins. The current pulse is still strongly dip-buy oriented across many market participants, we haven't gone into the full "I give up" stage yet. Equities while the bounces on crisis events are often with V shape formation, that has not been the case with crypto. The bounce and bull cycle rally is much flatter and dragged out, and the current macro environment agrees that this fits the situation more rather than not.

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