Why Is Bitcoin's Price Dropping?

The price of Bitcoin (BTC) has generally been declining since November, although the cryptocurrency's sharp price decline this week was likely triggered by rumors on Friday, Jan. 21, related to the U.S. regulation of digital assets.

Key Takeaways

  • Bitcoin's price on Tuesday, Jan. 25, was nearly 50% below its November high.
  • Rumors of a forthcoming U.S. government strategy to regulate digital assets may have triggered the current sell-off.
  • Gradual belt-tightening by the U.S. Federal Reserve may also be contributing to Bitcoin's price drop.
  • The price of Bitcoin is likely to be increasingly correlated with the prices of other assets.

Unidentified sources within the Biden administration said last week that the government is developing a strategy to address the economic, regulatory, and national security challenges posed by Bitcoin and other cryptocurrencies. The administration is reportedly also examining the opportunities created by the rise of digital assets, with the Biden administration's strategy potentially being made public as soon as February.

This likely report from the administration, while welcomed by those who believe that Bitcoin can benefit from greater regulatory certainty, has triggered some traders to sell their Bitcoin holdings. Bitcoin's price drop from more than $68,000 to current levels just above $37,000 is equivalent to the cryptocurrency losing nearly half its value.

The price of Bitcoin is also being affected by policy changes by the U.S. Federal Reserve. Federal Reserve Chair Jerome Powell said in December last year that the Federal Open Market Committee (FOMC) would double the monthly rate at which it reduces asset purchases. The Federal Reserve is now purchasing $20 billion less of U.S. Treasury securities each month and reducing by $10 billion each month its purchases of U.S. agency securities.

In his post-meeting press conference on Jan. 26, 2022, Powell indicated that the FOMC will adhere to the bond purchase schedule that it announced in December 2021. While the fed funds rate is being kept near zero for now, developments related to inflation may change that. Keeping elevated inflation levels from becoming "entrenched" remains a key focus for the Fed.

Measures enacted by the Fed that are designed to control inflation have had a negative impact on the price of Bitcoin. The values of risky assets—like Bitcoin—tend to decline in the wake of the Federal Reserve making policy changes to become more fiscally conservative.

More broadly, as Bitcoin matures and becomes more widely adopted, the price of Bitcoin is increasingly correlated with the prices of traditional assets like stocks. This growing correlation means that any event that triggers price declines in the traditional markets is likely to trigger similar or greater price declines for Bitcoin.

The Dow Jones Industrial Average on Tuesday lost more than 800 points before rebounding to post a loss at closing of less than 100 points. Similarly, the S&P 500 lost nearly 3% of its value before rebounding to post a loss of less than 50 points. The Nasdaq Composite Index, which tracks all of the stocks listed on the Nasdaq stock exchange, lost more than 3% of its value at the session low on Tuesday. Several non-U.S. indexes are also experiencing volatility and price declines.

Publicly traded companies with significant exposure to Bitcoin have been experiencing notable price declines. The stock prices on Monday of both Coinbase Global, Inc. (COIN) and MicroStrategy Incorporated (MSTR) declined by more than 15% at their session lows, although prices of both stocks stabilized somewhat on Tuesday. While Coinbase, as a cryptocurrency exchange, has direct operational exposure to Bitcoin, MicroStrategy is an enterprise software company that holds billions of dollars of Bitcoin on its balance sheet.

Should Bitcoin Investors Panic?

Bitcoin investors may not need to panic about the recent market sell-off, but it's important to understand the factors affecting Bitcoin's price movements. Rumors and government policy changes aside, investors should expect that the prices of Bitcoin and other digital assets will increasingly move in correlation with the prices of traditional assets.

Little-known cryptocurrencies may continue to trade at prices that are uncorrelated with the prices of traditional assets, but the same may not be true for the most-established cryptocurrencies like Bitcoin and Ethereum. Bitcoin investors concerned about the cryptocurrency's price can benefit from monitoring developments related to both Bitcoin and the broader financial market.

Ric Edelman, founder of the Digital Assets Council of Financial Professionals, told Investopedia that "this is the fifth time Bitcoin's price has fallen by 50% or more since its inception in 2009." While the most recent sell-off may not be a reason to part with your Bitcoin, the cryptocurrency's "massive price volatility reflect[s] the fact that this is still a new, emerging asset class, and experiencing growing pains." Edelman also notes that many investors "still view the long-term outlook [for Bitcoin] favorably," despite significant price volatility being "an inherent feature of Bitcoin."

Meanwhile, more regulation of Bitcoin and other digital assets may be forthcoming. The Federal Reserve on Thursday released a research report that explores the creation of a digital version of the U.S. dollar.

As of this writing, Bitcoin is currently trading at around $37,000, down approximately 45% from its high posted in November 2021.

Article Sources
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