Cryptocurrencies: Value Proposition Or Carnage Ahead For The Asset Class?

Source: Barchart

The Bitcoin chart shows the same pattern. Critical technical support for the leading cryptocurrency stands at around $28,900 per token to keep the bullish pattern intact. Since at the time of writing it's trading at the $37,000 level, the price remains significantly above that position.

Still, over the longer term, Bitcoin and Ethereum have experienced many explosive and implosive moves, ultimately leading to new record highs. No matter how scary, buying on price weakness has been the optimal approach to the asset class.

While Charlie Munger's colleague Warren Buffett is also not a crypto supporter, and has called the asset class “financial rat poison squared,” his investment advice about all markets reflects the trading pattern in cryptocurrencies. The Oracle of Omaha once said it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.” Early February 2022 continues to be a fearful period for the cryptocurrency asset class.

The ideological attraction of cryptocurrencies is that they are a means of exchange, but not fiat currencies. The U.S. dollar, euro, pound, yen, Chinese yuan and other currencies in the global financial system derive value from the full faith and credit of the governments that issue the legal tender. Governments manipulate the currency markets to achieve stability.

Following currency markets is a mirage as the market tends to measure values of one currency versus another. The U.S. dollar has been rallying, with the Dollar Index rising to its highest level since July 2020 last week. The prospects for higher U.S. interest rates have lifted the dollar’s value versus other world currencies as interest rate differentials are a primary factor in the path of least resistance for foreign exchange values.

Meanwhile, measuring the U.S. dollar and other fiat currencies against other assets reveals another story. The tidal wave of central bank liquidity and tsunami of government stimulus during the global pandemic lit an inflationary fuse that erodes all fiat currency values. As the faith and credit in governments declines, cryptocurrencies offer an alternative.

Their ascent over the past years is a barometer of falling confidence and credit deterioration. Crypto values come solely from bids and offers to buy and sell in the marketplace, without central bank or government interference. The ideological case reflects a libertarian political orientation. As fiat currencies decline, crypto’s value proposition improves.

Cryptocurrencies periodically implode. The ideological issue that supports their ascent is also a factor that could lead to their demise.

Governments worldwide control citizens through the laws enforced by the military and local authorities. They also control the supply of money.

Any parent knows that the best route for monitoring and controlling a teenager is via access to cash. Governments operate similarly, as controlling the purse strings via the money supply is a crucial component of power. Cryptos challenge that power.

China and Russia are not fond of cryptocurrencies and have banned trading and investing in the asset class. However, the Chinese government embraces blockchain technology and is in the final stages of rolling out a digital yuan.

However, in the U.S. and EU, governments move at a snail’s pace. Government and central bank officials in Washington and Frankfurt continue to express concerns about the illegal uses of cryptos and the future “systemic” risks they may pose. The genuine concern though is that cryptocurrencies challenge their control of the money supply and power.

Governments will slowly move to roll out digital currencies, while likely tightening regulations on the crypto arena as they embrace the evolution of the fintech revolution. Indeed, hedge fund manager Ray Dalio correctly said governments have the power to “kill” cryptos.

Cryptocurrencies are going through the fear phase after halving in value since the Nov. 10 peak, the height of the most recent speculative frenzy. One of the risks facing the crypto asset class in early February is the potential continuation of selling in the U.S. stock market and other asset classes.

As the U.S. Federal Reserve tightens monetary policy and geopolitical tensions rise, the equity market tumbled. The possibility for a severe correction—leading to a risk-off period across all asset classes—could push cryptocurrencies even lower.

Bullish and bearish trends often take asset prices to levels that defy logic, reason and rational analysis. Plus, it's challenging to identify fundamentals in the cryptocurrency arena, making them highly susceptible to continued price carnage during a risk-off period as speculators liquidate all risk positions and hide in haven assets like the U.S. dollar, bonds and other historical stores of value.

The fintech revolution will continue to challenge the status quo in finance even as governments, central banks and financial institutions remain behind the curve. Though cryptocurrencies could be a motivational force for them to embrace the revolution, its ideological underpinnings rejecting government control make for an epic battle between the burgeoning asset class and traditional macro and microeconomic assumptions and methods.

I view cryptocurrencies as a barometer of investor faith and trust in governments. Bitcoin may have halved in value since Nov. 10, but at the over $37,000-per-token level, it's a far cry from the five-cent level it traded at a dozen short years ago.

Value or carnage is a personal decision for market participants. The historical trading patterns suggest that at current prices, cryptos offer value. Ironically, the fear of carnage could also help fuel a digital token recovery, if prices go even lower, providing additional value for crypto enthusiasts.

Written By: Andy Hecht