Crypto during a recession: Here’s what to expect

Bitcoin and other cryptocurrencies have been on a roller coaster ride over the last 18 months, starting in late 2021, when the Federal Reserve announced that it would aggressively raise interest rates to combat inflation at multi-decade highs. Higher rates threw cryptocurrencies and other assets such as stocks into a tailspin, with many cryptos plummeting more than 70 percent at one point.

The market spent much of last year fretting about a recession, and many economists, if not most, expect a recession at some point in 2023. But how might Bitcoin and other cryptos fare in an economic downturn?

Crypto is no safe haven

As investors weigh the possibilities of a recession, many are looking for assets to protect them from the potential storm. But experts say crypto isn’t the place to find it.

“I’m not sure crypto can be considered a safe haven given its volatility,” says Scott Sheridan, CEO of online brokerage firm tastytrade.

Popular cryptocurrencies such as Bitcoin and Ethereum sank more than 70 percent from their all-time highs when investors shunned risk assets following the rise in interest rates. But crypto turned up in 2023, as expectations about an end to rising rates shifted traders’ mindset about the sector, though major cryptos are still well below their highs.

“The last year has busted the convenient myth that cryptocurrencies are a hedge against recession,” says Dan Raju, CEO of Tradier, a brokerage platform. “The truth is that crypto prices have proven to be impacted by the same directional sentiment that impacts retail stock investors.”

So, traders are likely out of luck if they’re looking for an asset that is poised to rise while the rest of the market is falling, especially riskier growth stocks.

“Bitcoin tends to show a positive correlation with the stock market, so from that point of view, a move in line with other risk assets makes sense,” says Julius de Kempenaer, senior technical analyst at StockCharts.com.

The countervailing force here is how the Fed is likely to respond if and when it becomes clear that a recession is underway. The central bank could lower interest rates to help spur the economy on, and that might help put a floor under crypto prices. That factor, however, must fight against the natural tendency of traders to avoid risk in a recessionary environment.

“During times of uncertainty, investors’ risk tolerance and investing habits tend to become more conservative as speculative trading becomes less desirable,” says Raju.

Raju expects the Fed will consider lowering rates in the fourth quarter in the face of slowing U.S. growth, a sentiment that’s reflected by the broader markets.

“I expect rate cuts to be favorable to crypto prices,” says Raju.

And don’t assume that Bitcoin – the bellwether for the crypto industry – will fare the same as other cryptos in a recession. What affects the most popular cryptocurrency may not have any effect on less-followed names.

“The volatility across the universe is so big that it will be hard to apply this assumption to the entire crypto space,” says De Kempenaer.

No reliable way to value cryptocurrencies

In crypto trading, sentiment is an even more potent force than it is in the stock market. That’s because cryptocurrencies have no intrinsic value since they don’t produce anything for their owners. Your return is entirely dependent upon selling it to someone else for a higher price. Legendary investors including Warren Buffett and Charlie Munger have strongly criticized the investment merits of Bitcoin and other cryptocurrencies for this reason.

“Crypto is an investment in nothing,” Munger told the Australian Financial Review in an interview in July 2022. “I don’t want to buy a piece of nothing, even if somebody tells me they can’t make more of it.”

Even those with a more positive view of Bitcoin and crypto assets acknowledge that valuing the digital coins is difficult, if not impossible.

“There is no established way to value Bitcoin,” says Noelle Acheson, former head of market insights at crypto lender Genesis Global Trading. “It’s narrative-driven – narratives can turn on a dime.”

Still, Acheson said she’s very bullish on the long-term prospects for Bitcoin. She sees a growing number of use cases for it and views it as an investment in new technology.

Crypto could get worse before it gets better

With the significant decline in crypto assets already and then a bounce off the bottom, traders may be wondering if the worst is behind us. But analysts still see plenty of risks on the horizon.

“The price of Bitcoin is not related to economic fundamentals, but [the] sentiment is,” Acheson says.

The last year has tested investors’ faith in crypto as an investment with a lot of sentiment-destroying news:

• TerraUSD, a so-called stablecoin meant to trade at $1, collapsed to a few pennies.
• Crypto-lender Celsius Network filed for bankruptcy.
• Three Arrows Capital, a crypto hedge fund, was ordered to liquidate by a British Virgin Islands court in June 2022.
• Popular crypto exchange FTX filed for bankruptcy after allegedly fraudulent activities.

“Institutional investors and major crypto exchanges are taking strain, and many are on the brink of collapse,” says Tammy Da Costa, a former analyst at financial market site DailyFX.

Crypto exchange Bittrex recently closed its U.S. operations and filed for bankruptcy in April, and an uncertain regulatory environment is hurting other exchanges and the broader sector in the U.S.

There’s no guarantee of a recession any time soon

Though fears of a recession have been elevated, there’s no guarantee a recession will actually occur. The U.S. economy continues to add jobs in the face of rising rates, and the unemployment rate remains at or near all-time lows of 3.7 percent, as of May.

If the U.S. manages a “soft landing” – a slowdown and then a bounce in economic activity without an actual recession – traders’ sentiment on crypto and risk assets such as stocks may rebound along with the economy. As risk appetite returns, crypto could be propelled higher.

So some crypto proponents say not to worry too much about the broader macro issues and instead focus on individual cryptocurrencies that could do well.

“Solid digital asset projects with real-economic utility will do well regardless of the macroeconomic environment,” says Dr. Martin Hiesboeck, head of blockchain and crypto research at digital money platform Uphold.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.