The cryptocurrency market has recently experienced a significant downturn, with the total market value falling by 10% between August 14 and August 23, reaching a low of $1.04 trillion in more than two months. The move triggered a massive liquidation of futures contracts, the largest since the November 2022 FTX crash.

Total cryptocurrency market capitalization, USD. Source: TradingView

Several economic factors contributed to this decline. As interest rates have breached the 5 percent mark and inflation remains above the 2 percent target, borrowing costs have risen for both households and businesses, weighing on consumer spending and the economic expansion. That means less money is available for saving, which could force people to forgo investments to pay their monthly bills.

With inflation expected to be 3.6% in 2024 and average hourly earnings rising 5.5% year-on-year, the fastest pace since 2020, the Fed is likely to maintain or even raise interest rates in the coming months. Therefore, a high interest rate scenario favors fixed-income investments, which is bad for cryptocurrencies.

Inflation has retreated from a peak of 9% to a current 3% and the S&P 500 is only 9% below its all-time high. This could point to a “soft landing” orchestrated by the Federal Reserve, suggesting that the chances of a long and severe recession are diminishing, temporarily weakening the investment thesis for Bitcoin as a hedge.

Factors Emerging in the Cryptocurrency Industry

Investors have high expectations for the approval of a spot bitcoin exchange-traded fund (ETF), especially with heavyweight endorsements from BlackRock and Fidelity. Those hopes were dashed, however, as the U.S. Securities and Exchange Commission (SEC) continued to delay a decision, citing concerns about insufficient safeguards against manipulation. Complicating matters further, a large number of trades using stablecoins continue to take place on unregulated offshore exchanges, raising questions about the authenticity of market activity.

Financial difficulties within Digital Currency Group (DCG) also had a negative impact. A subsidiary of DCG is grappling with more than $1.2 billion in debt on the Gemini exchange. Additionally, Genesis Global Trading recently declared bankruptcy due to losses from the collapse of Terra and FTX. This precarious situation could lead to a forced sale of the Grayscale Bitcoin Trust’s position if DCG fails to meet its obligations.

Tighter regulation further exacerbated the market’s woes. The U.S. Securities and Exchange Commission (SEC) has filed a series of charges against Binance and its CEO, Changpeng Zhao (CZ), alleging misleading conduct and the operation of an unregistered exchange. Likewise, Coinbase has faced regulatory scrutiny and lawsuits over the classification of certain cryptocurrencies as securities. Highlight the ambiguity of US securities policy.

Dollar strengthens despite global slowdown

Signs of trouble from China’s slowing economic growth have also emerged. Economists have lowered their growth forecasts for the country, and both imports and exports have fallen in recent months. In the second quarter, China’s absorption of foreign investment fell by more than 80% year-on-year. Worryingly, private Chinese developers have unpaid bills of up to $390 billion, posing a major threat to the economy.

Investors have shown a tendency to flock to the perceived safety of the U.S. dollar despite a deteriorating global economic outlook, which could boost the appeal of bitcoin due to its scarcity and fixed monetary policy. This is evidenced by the action in the US Dollar Index (DXY), which has surged from a low of 99.5 on July 17 to its current level of 103.8, its highest in more than two months.

US dollar index (DXY). Source: TradingView

As the cryptocurrency market grapples with these multifaceted challenges, the ebb and flow of various economic factors and regulatory developments will undoubtedly continue to shape its trajectory in the months ahead.

This situation may be the result of over-optimism following the submission of multiple spot Bitcoin ETF requests in mid-June, so rather than focusing on what caused the recent 10% pullback, it is better to question whether the rally in mid-July came from a 10% pullback. First, a $1.0 trillion market cap at $1.18 trillion is plausible.