Notes 2/2: Bitcoin Price

The Fed stuck to an expected script yesterday and announced a quarter percentage point hike in interest rates.

The market’s response to the Fed’s announcement was enthusiastic. The S&P 500 closed with a 1% increase while the Nasdaq Composite advanced by 2% to 11816.32. The Dow Jones Industrial Average (DJIA) rose by 6.92 points to 34092.96.

Bitcoin prices also jumped. The biggest cryptocurrency by market capitalization pushed past the $24,000 mark briefly before losing its gains. As of this writing, it is changing hands at $23,858.31.

Does The Rally Have Legs?

The price rise for Bitcoin and crypto markets is predicated on availability of more cash for investors to put money into risky assets like Bitcoin and push up their prices.

But that optimistic take might be misplaced. In regulated markets, the promise of a further loosening in monetary policy translates to more investors and trading volatility and profits. Cryptocurrency markets are already notoriously volatile.

In recent times, the overhang of erupting scandals has made them even more toxic and resulted in low liquidity and declining transaction values. The current rally in bitcoin prices may be a short-lived chimera. Even the possibility of moderation in future interest rate increases by the Fed might not be sufficient to prop up its prices in the long term.

Bitcoin Price Manipulation

There are the macro factors that affect bitcoin price. And, there are the fundamental and technical factors, relating to the crypto’s liquidity and on chain parameters, that influence it. And then, there’s Tether.

The stablecoin, which powers most transactions in crypto, has been accused of inflating bitcoin price by increasing its supply in earlier studies. Now those charges are being refreshed.

In a Fortune article, John Griffin, a professor of finance at the University of Austin’s business school, said a select group of whales are colluding to keep bitcoin price above a certain floor, say $16,000 based on the cryptocurrency’s price movements in the last five months, and ensure that major players in its ecosystem remain above water.

Griffin and his students authored papers in 2018 and 2019 that analyzed data from bitcoin price rallies in 2014 to 2017 and demonstrated a link between increased supply of Tether and rising bitcoin prices.  

As I have written before, redeeming Tether is an obstacle-ridden task. The most convenient way to get out of a Tether transaction is by trading it against bitcoin and, subsequently, converting the latter into US dollars. Recent news reports state that the present increase in Tether’s supply is indicative of another rally in bitcoin price.

Tether Supply and Bitcoin Price

But Tether’s supply in the markets has followed an erratic curve.

Based on data from Coinmarketcap, it was 67.81 billion on Jan. 31, up by roughly 3.7% from the end of November last year. On October 24, it stood at 68.45 billion. Last June, it was 71.06 billion, down from 82.69 billion on April 15.

In fact, the biggest dump of Tether came between April and November of 2021 – a period during which bitcoin price set two records – when the stablecoin’s supply skyrocketed from 45.85 billion on April 14 to 73.86 billion seven months later.

That is not the end of it. Tether supply continued to increase and reached 82.69 billion in April 2022. Bitcoin price, meanwhile, slid downwards in this period.

Collusion As Explanation

This means that the correlation between an increase in Tether supply and bitcoin price pumps may have weakened in recent times. In their papers, Griffin and his students identified Bitfinex, which issued Tether at that time, and a couple of other exchanges as the instigator of such rallies.

Times have changed.

In the Fortune article, Griffin has latched onto the idea of collusion among select players in crypto to explain the cryptocurrency’s recent price movement. He says a group of whales – a term used to describe those with large bitcoin holdings – can set a price floor for the cryptocurrency because it has low liquidity. If the price threatens to breach their floor, the group moves into the markets and props up the price.

That idea may not be as fantastic as it sounds.

Tether has ceded some of its share, and influence, in the stablecoin market to other coins. Regulated futures instruments exist to short bitcoin price enabling external players to exert an influence, though extremely limited since most crypto derivatives remain unregulated, on its price.

Recent bankruptcies and unraveling of crypto companies have already exposed the interrelationships between players in its ecosystem. It is likely, then, that the setting and propping up bitcoin price requires more work as compared to 2017.

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