One of the main promises crypto comes with is that Bitcoin is a recession proof digital asset that might even go up as the whole traditional finance goes down. And as the Covid pandemic progressed, many where inclined to confirm that theory as BTC reached $60K.
Yet the war in Ukraine and a fearful investing market seem to show cryptocurrency assets to react just like other investment products do.
Still, the market expects Bitcoin to rebound and claim new all-time highs in the future. And the enormous volatility seems to permit that while sacrificing the potential “a safe haven for investors” title.
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 a financial crisis is 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.
That specific situation may 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.
However, in 2021, things changed dramatically as the economy opened, triggering an “everything bull-market” with stocks, crypto, and general business activity flourishing.
Yet, in 2022, the war in Ukraine, the rising energy costs, the inflation, and the general FUD slashed the growth from the previous year.
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 number of Bitcoins, inflation doesn’t apply. Furthermore, it is considered the digital alternative for gold, as a store of value.
Yet, falling from almost $60,000 to almost $20,000 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 although the consensus is that cryptocurrency is going through a bear market, such a drop doesn’t mean a complete crypto crash.
Bitcoin and altcoins recovered time and time again.
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. And with Ethereum going to fully PoS, this case gets even stronger.
Best case scenario
Cryptocurrencies indeed lost more than 70% of their value in a few months. It’s their bad habit to keep acting like that.
The massive selloffs in all markets, the FTX crash, and the FUD do not help. But Bitcoin is not a company and cannot go bankrupt and disappear. And when Bitcoin gains trust, all the crypto market gains trust.
In the best-case scenario for the crypto market, due to the general low performance of financial assets, and the BTC history of crazy gains, the demand may rise and so will the prices.
Bitcoin is considered by many to be the “digital gold” and is expected to behave differently than other assets throughout a recession. However, Coronavirus, the war in Ukraine, and the rising inflation are keeping the markets down.
Although cryptocurrencies suffered a downturn all together with traditional markets, the crypto crash is not coming. Moreso, the crypto market seems to be holding it together.
Within this socio-economic situation, the next Bitcoin halving event and Ethereum’s transition to proof of stake still keep the crypto market hopeful.