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For months, Bitcoin traders lamented how an asset known for its violent volatility had suddenly turned into a quasi-stablecoin, trading around the $29,000/$30,000 mark and refusing to budge.

They have got their wish in the last couple of weeks, although it may not have been in the direction some desired. Two weeks ago, Bitcoin suffered its biggest daily drop in nine months, when FTX’s collapse sent the market into a tailspin. On Friday of that week, its fall of 7% represented the biggest move in either direction since the regional bank crisis of March. But why?

A few factors may have contributed to Bitcoin’s tantrum, but as always, macro was at the heart of the storm. 

Yields rose across the market, a development that tends to damage risk assets such as Bitcoin. Yields on long-term US government debt neared their highest level since 2007, UK 10-year gilts rose to their highest yield since 2008, and Germany’s 10-year bund reached its highest yield since 2011. 

The sell-off in bonds came via increased bets on a more hawkish interest policy than had previously been anticipated.  This in turn was a result of the good news is bad news conundrum. In short, the economy has been surprisingly resilient, which should be a positive thing, but in a world where inflation remains a pernicious problem, means central banks may be forced to keep interest rates higher for longer – or even implement more hikes. 

Last week, the Federal Reserve’s minutes spelt out this fear: 

(We see) significant upside risks to inflation, which could require further tightening of monetary policy

We had warned about this fear, wondering had the market – crypto or otherwise – got ahead of itself amid some bearish signals, including a deeply inverted yield curve, sticky core inflation, record lows in unemployment and upward wage pressure, all against a sharp rise in valuations already this year. 

The bond market ultimately acted on these fears, a more hawkish position sending risk assets across the financial sphere tumbling. Bitcoin was caught in the crossfire. 

Indeed, while the ignominious collapses within crypto as a result of reckless risk management and overleverage have undoubtedly dented the asset significantly, the reality over the last eighteen months is that this is a high-risk asset that has had the rug pulled out from under it as the world transitioned to a tight monetary policy. 

In this chart, we have plotted the Bitcoin price against the 2-year treasury yield, going back to Bitcoin’s all-time high in November 2021. The relationship is clear (note that the yield is plotted on an inverted axis). 

As discussed, macro was undoubtedly the biggest driver of the drop. However, there were other factors that may have amplified the move. As always with Bitcoin, it is hard to know, but there were some reputable theories. 

The first is an obvious one, and not just specific to the recent dip. Liquidity is extremely thin and means a return to volatility was always on the cards. Order depth on exchanges is very shallow, while volumes have been lagging, leaving moves vulnerable to being amplified as less capital is needed to move prices. 

Specific to the recent fall, however, there were some events that may have spooked the market more than what otherwise would have happened. The first was a report that Elon Musk’s SpaceX may have sold all its Bitcoin. The Wall Street Journal ​​reported that SpaceX wrote down the value of its Bitcoin by $373 million, citing internal financial documents, although SpaceX is private and is unclear whether the company still retains some Bitcoin, or whether it sold it all.  

SpaceX wrote down the value of bitcoin it owns by a total of $373 million last year and in 2021 and has sold the cryptocurrency

However, as we keep seeing, it feels like if this had any impact at all, it was merely to slightly encourage sellers who were already selling – stacked against the macro developments earlier, this is nothing but a drop in the ocean. 

The other factor feels similarly insignificant in comparison, but the news that China’s Evergrande is filing for bankruptcy is one that is a little more complex. Formerly China’s largest lender, Evergrande has long sparked concern around the market’s leading stablecoin, Tether.

This is because of the long-running controversy around Tether’s reserves. A report in 2021 revealed that close to 50% of Tether’s backing was in the form of commercial paper and unsecured promissory notes issued by corporations. When Evergrande came under pressure, this led to concern in the market that Tether could be caught in the form of its commercial paper holdings. 

The company denied any direct exposure to Evergrande’s debt, however, although the exact details of Tether’s holdings were not published. The worry was that Tether held commercial paper held by other Chinese institutions and hence would be vulnerable to the broader economic climate in China, and therefore the fallout from Evergrande’s trouble. 

Ultimately, this fear is no longer as prominent as it was, however. Tether announced it had completely eliminated commercial paper from its reserves last October. Again, while the story gained traction in crypto circles, it is unlikely to have moved the needle.  

Tether just reached 0 commercial paper. Zero.
Seguimos. https://t.co/usd4RRNfRV pic.twitter.com/lezUu9LwxQ

Ultimately, this was a recalibration around expectations of the future path of interest rates, clearly seen by movements in the bond market. The economy remains in a unique state – tight monetary policy, falling but still-elevated inflation, while also seeing unemployment close to 50-year lows. 

At the end of the day, Bitcoin is just an asset in this greater game, prone to the whims of the wider economy. When we throw in the thin recent liquidity and volumes, and a historical propensity for volatility, developments such as last week’s sudden fall are not a shock. 

The unusual thing this year is that Bitcoin’s climb has been slow and steady, rather than dotted with spikes and pullbacks as is normally the case. Volatility has been incredibly low, but last week highlighted that Bitcoin, and this current highly unusual macro climate, still has the capacity to move quickly. 

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