Bitcoin And The Tax-Loss Harvesting Rally (BTC-USD)

I have been bearish on Bitcoin (BTC-USD) since my article in October of 2021 when I saw the risk of regulation coming amongst other threats. Investors have cheered the January rally in Bitcoin but it is technical in nature and nothing has changed fundamentally in the world’s largest cryptocurrency.

The Bitcoin rally was a tax-loss harvesting short squeeze

Bitcoin’s rally in January surprised the market with a surge from around $16,000 to touch $24,000. However, further gains could be hard to come by as nothing has fundamentally changed for BTC.

Bitcoin started November around the $21,470 level and now trades at $22,586 with the recent stalling hinting at a return to $21-21,500.

The November dump was created by the FTX collapse, while we saw a further dip from December. Many cryptocurrency investors, especially institutions, will have taken advantage of tax loss harvesting. Tax-loss harvesting is an investment strategy that can be used by investors to limit future tax liabilities by using losses in a current investing year.

In stock markets, tax-loss harvesting comes with the risk of IRS scrutiny as an asset, sold and re-purchased within 30 days, can be classed as a “wash trade”. Although there is no formal regulation on crypto, selling ahead of December would’ve been astute to do ahead of pending regulation.

The heavy buying of Bitcoin in early January also created a huge short squeeze, so the rally in Bitcoin is purely technical. If we needed a bell to ring then a Barron’s article predicting a “GameStop moment” in Coinbase (COIN) could be it.

I advised my subscribers to buy Coinbase back on January 11 for a potential rally of 100% and it made a quick 70%, but I advised that it was a short-term trade, rather than an investment.

Miners rush to sell BTC as the industry consolidates

The Bitcoin mining industry suffered in 2022 as debt-laden miners struggled with the bear market in Bitcoin prices.

The industry has now turned to consolidation as a means to survive with the merger of Hut 8 (HUT) and US Bitcoin announced this week. The move comes after bankruptcies in the mining industry. While some miners were able to pick up new mining rigs and facilities at distressed prices, others like Austin’s Core Scientific filed for bankruptcy. Greenidge Generation Holdings (GREE) has now announced a debt restructuring with its creditors in late January and Pennsylvania’s Stronghold Digital (SDIG) did the same this week.

Another aspect of these activities is that companies have used the recent rally to cash in some of their bitcoins to pay operating expenses. Nevada-based, Marathon Digital Holdings (MARA) said last week in its production update that it would sell 1,500 BTC to fund operating costs.

“Marathon may continue to sell a portion of its Bitcoin holdings in future periods to support monthly operations, manage its treasury, or for general corporate purposes,” the company said.

If the Bitcoin price continues to stall then further miner selling could cap any price gains. Another feature of that is that the rally has helped other beaten-down crypto investment firms that have struggled in the downturn. Forbes magazine estimated in August that 51% of Bitcoin trades are bogus, which raises further questions about liquidity.

Regulation and other risks still weigh on the Bitcoin outlook

The rally in Bitcoin has been technical in nature and nothing supports any real changes in the coin’s outlook. Institutions were afraid to buy into cryptocurrency and that has only worsened with the FTX fallout and the lack of regulation and transparency. There are many risks for the crypto market which include Binance. I wrote an article on Binance which highlights its risk to the overall market as it is the largest trading exchange with a 24-hour trading volume of $15-20 billion against the $1.5-2 billion of its nearest rival, Coinbase. Binance was not very transparent about its reserves and is constantly under scrutiny with a recent money laundering probe and the links to the seized exchange Bitzlato.

The real big risk is in regulation as the market police step up their efforts with a stronger mandate following the collapse of the FTX empire. Bitcoin’s recent price drop is being attributed to news that another crypto exchange is coming under SEC scrutiny. The regulator was investigating San Francisco-based exchange Kraken for violating securities laws, according to reports. It was later reported that Kraken was paying $30 million in a settlement and agreeing to end its crypto staking operation in the U.S. Rumors are swirling that Coinbase will also be forced to end its staking, which could add to the recent job cuts at these companies.

The SEC charged the Gemini and Genesis exchanges with securities violations in January and it could be the start of an enforcement wave, after the SEC’s Chair, Gary Gensler, said previously that “most” cryptos were securities.

Investors must look at one important aspect of the SEC’s work. They went after Ripple to slow the progress of payments, they went after Binance and now Kraken to slow the growth of exchanges, and they even investigated the creator of the Bored Apes NFT collection. Those moves, combined with the charges against Gemini when the exchange was close to bankruptcy are a clear sign that the SEC is applying force and will continue to do so.

Global regulation is a mechanism that looks set to clip the wings of the decentralized newcomers and serve the current financial system players. The International Monetary Fund is prevalent in wanting to regulate the industry and they set out their ideas after the FTX issues, which I have summarized as follows:

1. “We believe that crypto asset service providers delivering critical functions should be licensed, registered, and authorized”. That will require audits of the exchanges and enhanced scrutiny.
2. “The recent FTX failure showed how the combination of exchange, wallets, and market-making services under one group creates significant risks to the customers. It is particularly important that customer assets are segregated from other functions.”
3. “Stablecoins issuers should be subject to strict prudential requirements. We need strong, bank-type regulation for stablecoins, and central banks should take the lead in such an endeavor given stablecoins’ potential presence in the monetary system”. Yet more audits.
4. “There should be clear requirements on regulated financial institutions, concerning their exposure to, and engagement with, crypto”.
5. “Eventually, we need robust, globally consistent, comprehensive regulatory responses to achieve effective crypto regulation and supervision. The cross-sector and cross-border nature of crypto assets limits the effectiveness of uncoordinated national approaches”.

In short, bye, bye to a decentralized financial system. Cryptocurrency will simply be a digital version of the current system, overseen by the same institutions.

Finally, in the case of contagion, the market may not be over the worst as another BTC downturn would increase the heat on the mining industry and struggling firms like Silvergate Capital, (SI) which could be the next company to go bankrupt, and even threaten its troubled conglomerate, Digital Currency Group.

Big banks step into the digital money arena with

Although some investors doubt the ability of Central Bank Currencies (CBDCs) to get off the ground, all major countries are studying the option, with the UK pushing it harder recently.

The Bank of England and the UK Treasury aim to introduce a digital pound by 2025.

Another threat has emerged to decentralized money in the form of a digital payments project that will target the dominance of ApplePay and PayPal. JP Morgan (JPM), Bank of America (BAC), and Wells Fargo (WFC) are among the firms launching a digital payments wallet via their joint venture with Early Warning Services, LLC, which manages their Zelle Payments Network.

The big banks are looking to target the popularity of their digital rivals with PayPal (PYPL) having more than 400 million active wallets in 2022, while Apple Pay had over 500 million active users.

It is clear that we are moving to a digital age of money. However, it is still looking unlikely that the global payments system will be decentralized.

Conclusion

Bitcoin investors have cheered a sharp rally in January that was largely spurred by tax-loss shuffling and a big short squeeze. As the dust settles on that retail move, the cryptocurrency world is no closer to mass adoption or institutional buying. The arrival of digital payment options from the big Wall Street banks and the fallout from the decentralized finance and FTX exchange collapse could mean it is even further away. Bitcoin is currently a trading vehicle that tracks Fed rate hikes and inflation, while it reacts to negative sentiment from regulation etc. Investors should treat it as such and not get carried away in the hype.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.