Why Are Digital Assets Under Pressure?

Fears of a looming recession continue to fuel uncertainty in the global equity markets—no wonder the vast majority of indexes and securities are down double-digit percentages so far in 2022. Things are even worse in the cryptocurrency industry: BTC/USD pair is down 58%, whereas ETH/USD is down 63%. Overall, the digital asset's market capitalization stands way below its $2 trillion record.

Such a weak performance compared to its peers could be explained by a significant Risk-Off environment in the global markets, triggered by a restrictive monetary policy by Central Banks. Long story short, Investors tend to be reactive and risk-averse when bigger issues are considered. The fact that Jerome Powell said that further interest rate hikes are necessary to fight inflation makes for a perfect storm.

According to Bridgewater Associates' founder estimates, a rise in rates from where they are to about 4.5 percent will produce about a 20 percent negative impact on equity prices. Goldman analysts' worst-case scenario would be a 26% fall of the S&P 500 from the current levels. Last but not least, a former top TD Ameritrade technical analyst warned the market could fall another 22%.

Talking about projections, U.S. GDP growth in 2023 is expected to be 1.2%, instead of the 1.7% previously forecast. The unemployment rate has also been revised downward from 3.9% to 4.4%. The average interest rate next year is expected to stand at 4.6%. Thus, traders should be getting ready for a bumpy road ahead unless Fed concerns over inflation simmer down.

The growing correlation between crypto and equity markets suggests that digital assets also suffer. Adding more fuel to the fire, crypto regulation is gaining momentum worldwide. Before the European Union finalized the full text of its landmark Markets in Crypto Assets legislation, the White House released the “First-Ever Comprehensive Framework for Responsible Development of Digital Assets.”

Theoretically, its final goal is to:

• Protect the rights of consumers and investors;

• Ensure financial stability;

• Fight illicit financial flows;

• Maintain U.S. global financial leadership and economic competitiveness;

• Make financial services accessible;

• Fostering "responsible innovation."

  
  

Among other things, the document defines the range of government agencies that will oversee the cryptocurrency market and defines their main functions. For example, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) will investigate fraud, theft of cryptocurrency assets, etc.

To combat money laundering and counterterrorism, the White House plans to initiate amendments to the Bank Secrecy Act and other regulations that would extend financial market regulation to digital assets and players in that market, particularly cryptocurrency exchanges and NFT platforms. In summarizing, get ready for a “big Reboot.”

What does all this mean? First, that crypto is already integrated into the financial system. Second, that you can forget about anonymity (if it ever existed). Third, with a push to develop CBDCs, stablecoins could face battles with regulators. As a result, one or the other could go belly up.

It is worth mentioning that as part of the legal proceedings related to a market manipulation case that dates back to 2019, Katherine Polk Failla, a judge for the U.S. District Court for the Southern District of New York, has ordered Tether’s parent company to provide financial records for its USDT stablecoin. Good thing it remains kinda stable.

Forget about traditional risk management. The main issue with this strategy is that when BTC goes down, practically the entire digital asset market suffers. Therefore, I would raise holdings in alternative assets or even think about cashing out. As for Ethereum, SEC chief Gary Gensler said the cryptocurrency could be considered security after moving to Proof of Stake.

Under the current Securities Act, cryptocurrency companies that provide crypto asset staking services are required to pass the Howey test. Under that test, an investment contract exists if there is an "investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others." In short, the cryptocurrency market begins a new chapter, and it does not seem to be for the benefit of the users.

May the Force be with you…