Bitcoin (BTC 8.18%) stands out in the cryptocurrency industry because of its strong brand and first-mover advantage. And with its price down 52% year to date, many investors are wondering if now is the time to bet on a rebound. Let's discuss two factors to consider before clicking the buy button.
Bitcoin isn't a safe haven against inflation
The experiences of 2021 and 2022 suggest Bitcoin is not a reliable hedge against inflation. Despite a skyrocketing annual inflation rate, the asset has shed most of its pandemic-era gains. And the Federal Reserve's monetary policy tightening could be behind this unexpected trend.
The U.S. inflation rate hit 9.1% in June -- far above the Fed's target of 2%. To cool things down, the central bank is reducing its balance sheet and increasing interest rates -- two moves that increase the cost of capital and reduce the amount of money circulating in the economy.
When capital is scarce, investors become less willing to risk it on speculative assets like Bitcoin. And with many economists expecting the Fed to continue raising rates until late 2023, this headwind should be on the minds of investors looking to bet on a crypto rebound. Before calling the bottom, I would like to see inflation peak and begin to fall, which will reduce the Fed's incentive to continue tightening.
The dust hasn't settled yet
The cryptocurrency market value has fallen over 50% (to about $1 trillion) in 2022 alone. This rapid decline has led to a shakeout of riskier projects with flawed business models.
This month, popular crypto lending platform Celsius filed for bankruptcy after liquidity challenges resulting from the market's decline. The crisis follows the collapse of Terra/Luna, a $60 billion (at its peak) stablecoin platform that fell to practically zero after losing its peg to the dollar.
As an established cryptocurrency with a relatively simple use case (namely, a way to store and transmit value), Bitcoin is shielded from many of the volatility-related challenges faced by newer, more complex rivals. But its trust and stability can be a double-edged sword.
For example, the failed Terra/Luna project held reserves of Bitcoin to help maintain its stablecoin peg. When the project collapsed, these assets were released into the market, putting selling pressure on Bitcoin. Considering the risk of contagion from other assets, investors may want to wait for the dust to settle before jumping back into the Bitcoin market.
Bitcoin is still a long-term winner
With its huge scale and strong brand, Bitcoin still looks like a long-term winner in the cryptocurrency industry -- especially now that the market plunge has exposed the weaknesses of some of its newer rivals. That said, rising inflation and Fed tightening look like near-term challenges for the crypto market as a whole. And the panic in altcoins could put selling pressure on established cryptocurrencies like Bitcoin. Investors looking for the bottom of this bear market should be careful not to jump the gun.
Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.
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