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Why Is Crypto Exploding Now?

Validated Individual Expert

Yesterday, January 14th, Bitcoin crossed the $20,000 price mark for the first time since the downfall of FTX around two months ago.

In the last week alone, it has increased its price by 20%!

But Bitcoin isn’t the only one rallying.

  • Ethereum is up almost 14% over the last five days
  • Solana a mind-boggling 68% (thanks to the useless cryptocurrency Bonk)
  • Avalanche an amazing 42%
  • Since January 1st, the total Crypto market has rallied 21%, from $756 billion to around $916 billion at the time of writing

Have all the Crypto market participants suddenly introduced ground-breaking technological advancements to explain this increase?

No.

Then, what’s going on?

The reasons are more about pathological gambling and misjudged decisions and less about logic.

Because logic was long lost when it comes to the emotion-driven financial markets.

And while stocks and cryptocurrencies rally, four hidden words in the Q4 earnings reports of two of the biggest investment banks in the world, albeit trying to disguise it, tell a much different story for the world in 2023.

The truth? That probably nothing should be going up.

Inflation decline and a ‘little’ speculation

Cryptocurrencies, to this day, are still very correlated to stocks. Thus, as stocks rallied, so did Cryptos.

But why are stocks around the world rallying?

First, let’s cover the “official” reason:

  • The Consumer Price Index for All Urban Consumers was released, painting a picture of declining inflation in the US of 0.1%, leaving it at a still extremely high value of 6.5%

This result gives hope that the Federal Reserve’s rate hikes won’t be as big as the ones we’ve been suffering for months now.

But why does this matter so much?

When central banks hike interest rates, this means that fiat currencies, like the US dollar, go up.

This, in turn, means that borrowing money becomes more expensive, which entails a tendency of consumers to spend less, and less spending means less revenue for companies, which equals lower economy growth.

Smaller rate hikes signal not only the end of this tightening, but also a potentially-better scenario for the economy.

In the end, it’s all about hope.

The markets are going up in hopes that recent “good” news picture a much less painful future for the economy in 2023.

However, what we call ‘hope’ is none other than a euphemism for rampant speculation when it comes to financial markets. And it all boils down to one human trait:

The natural tendency of investors to think that they can predict the future when in reality they can’t.

The Dunning-Kruger effect

Sam Parr, a famous podcaster, recently launched a question to its 200K Twitter audience.

Pure delusion

The question was as follows:

“If you could guarantee a steady 8% annual growth, every year forever, for your savings…BUT …you cannot invest money in anything else like:

— individual stocks

— alternative investments

— startups (other than your own business)

Would you do it?”

The results were incredible.

The majority of people said ‘no’. They trusted themselves to beat the markets.

If you also feel that way, let me tell you something that will change your life.

Compound interest, the 8th great world wonder

Once you meet interest compounding, there’s no looking back.

However, the magic of compound interest is that it doesn’t feel life-changing until you make some calculations.

This is what a $1000 initial investment with $150 monthly contributions during a 50-year timeframe looks like: $1,079,687.89 for a total contribution of $91,000.

If that’s not sending shivers down your spine, this graph will:

The return on that hypothetical investment. Source: investor.gov

Yes, that red line is what you would have after 50 years, and the blueish one would be how much you’ve committed to that investment during those same 50 years.

A million-dollar return. But there's a catch.

A guaranteed 8% over 50 years has the same probability as getting bitten by two white sharks at the same time.

Some lucky people do get bit

Only a few exceptions break the norm. Like Warren Buffett or Peter Lynch, for instance.

To illustrate again how powerful compounding is, since 1965 Berkshire Hathaway, Warren Buffet’s firm, has achieved an astonishing 20.8% per return per year, while the S&P 500 has had a 9.7% return.

This may seem as Berkshire Hathaway has had two times better performance, right?

Well think again.

A $10k investment on the S&P 500, without considering annual fees from brokers, would have yielded $1.23 million. That same investment put on Berkshire Hathaway?

185 million. And that’s not 2 times better, it’s 150 times better.

Nevertheless, besides the truly astonishing results of Berkshire Hathaway, predicting the market has proven to be impossible for the majority.

Then, if the chances of beating the market are close to none, why people would reject the awesome offer that Sam made them?

It’s the Dunning-Kruger effect.

Overestimating yourself

The Dunning-Kruger effect is a cognitive bias in which people who lack knowledge or expertise in a particular area overestimate their own level of skill or ability.

Humans, by default, think they are ahead of the curve.

And that couldn’t be further from the truth.

But human incapacity to acknowledge its limitations isn’t the only thing that, in my opinion, explains why this price rally shouldn’t be occurring.

There are two other things: ‘provision for credit losses’ and ‘Reg M’.

And while I know for a fact that that sentence didn’t make sense at all, it will make a lot of sense for you in seconds.

Smart money knows something the majority doesn’t

Yesterday, banks released great earning reports.

For instance, JP Morgan and Bank of America rallied as a result. But when analysts delved deeper, they found something very concerning.

Banks are provisioning billions for potential credit losses.

Now, what on Earth is that?

It’s a message to the world.

Credit defaults, that damn word again

The 2008 crisis can be easily explained as a process from ‘house prices never go down bro’ to… house prices collapsing after thousands of borrowers who shouldn’t have been allowed to borrow in the first place defaulted on their loans.

That is, as banks lent money like candy, the moment people stopped paying their loans (a concept known as credit defaults) banks suddenly realized they were screwed (they unscrewed themselves and survived by screwing others, but that’s a story for another day).

This created one of the biggest financial crises in history.

Now, banks are starting to fear that credit defaults will start trending again. And this is where credit loss provisions come in.

JP Morgan has provisioned $2.3 billion and Bank of America $1.1 billion to cover potential credit losses.

In layman’s terms, they are saving money, in case customers stop paying, to cover potential payment defaults. If this tells us something, is that these banks are predicting that things are going to start going south for many people in 2023.

But this isn’t the only thing that should have Crypto enthusiasts worried.

A $1.6 billion hole and the ‘Reg M’ procedure

The Digital Currency Group, otherwise known as DCG, is reportedly in a lot of trouble, as they owe Genesis Trading, their Crypto lending company, a whopping $1.6 billion.

The problem is that this issue also affects the world’s largest Bitcoin trust, Grayscale, also part of DCG, in unknown but very scary ways.

But what’s Grayscale?

Grayscale offers closed-end funds for Bitcoin, Ethereum, and a smattering of other digital currencies.

A closed-end fund is a type of investment fund that raises a fixed amount of capital through an initial public offering (IPO) and, unlike mutual funds, closed-end funds have a fixed number of shares that are issued and traded on an exchange.

This can create a disparity between the prices of the shares and the prices of the underlying assets.

For instance, in Grayscale’s Bitcoin trust, its shares (GBTC) are currently trading below the value of the underlying Bitcoin at an incredible 44% discount.

Consequently, GBTC investors hold an investment that’s performing 44% worse than if they bought Bitcoin directly. But if Grayscale’s Bitcoin trust is in a bad spot, their Ethereum trust is no better, trading at a 47% discount.

And knowing these values is where things get worrisome.

A potential collapse

For DCG’s liquidity issues stated earlier, it could be forced to turn its trusts into Reg M procedure.

This would allow Grayscale clients to redeem their crypto in a 1:1 ratio, allowing Grayscale to then sell off their shares at a discount in an effort to raise money to “pay the bills”.

Now think about this for a second.

Suddenly, the two biggest Bitcoin and Ethereum trusts in the world could collapse, introducing 632k Bitcoin (valued at $11 billion) and 3.04 million Ether (valued at $3.81 billion) into the markets — introduce doesn’t mean sell, but adds selling pressure.

This could crash the value of both cryptocurrencies as panic would flood the markets.

Will markets stay bullish if that happens? Are you sure this is priced in?

Nobody knows

In summary, in my humble opinion markets aren’t pricing in many of the negative prospects the markets are setting for 2023.

For the sake of my long-term investments, I hope I’m wrong, but neither you nor I know what will happen.

Nonetheless, to me there’s one certain thing, the actual 21% price increase in Crypto makes no sense to me.

At all.

Become aware. Be ready

In times of uncertainty, the only certainty is knowledge.

While staying ahead of the curve in markets seems unlikely, it’s impossible unless your awareness is top-notch.

Luckily, you can be up-to-date with the main Crypto and AI events that are shaping our future in a 5-minute easy-to-read email sent every week, cutting through the noise to deliver digested content suited for those that want to stay ahead of the cure.

That care about winning.

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