Bitcoin falls after a big rally. It can get ugly.

“Bitcoin prices weaken as growth fears have Wall Street worried that a soft landing may not happen. The outlook for crypto has improved dramatically in recent weeks, but the current rally looks to finally be facing some resistance,” says Edward Moya , analyst at the broker Oanda.

Bitcoin had slumped for two years in the wake of FTX’s bankruptcy, falling to near $15,500, and had stagnated between $16,500 and $17,000 for several weeks before beginning its march higher last week in its longest winning streak in nearly a decade.

But the momentum began to turn the following Thursday

Dow Jones Industrial Average

and

S&P 500

fell on Wednesday — the stock market’s worst day of 2023 so far — and was poised for more losses during the day. Investors fear that the Federal Reserve will not be able to engineer a “soft landing” — bringing inflation under control while avoiding recession — with concerns spilling over from stocks to crypto given the correlation between the two risk-sensitive assets.

“Bitcoin is still holding above $20,000. Indices may still decline further to find a local bottom in the next few days, Bitcoin is likely to be supported at the psychological level of $20,000,” said Yuya Hasegawa, analyst at crypto exchange Bitbank . “In other words, Bitcoin’s fall is likely to be shallow.”/// UPDATE STARTS

But there is still risk if crypto prices weaken much longer, because the rally that drove Bitcoin higher was largely built on sand in the first place.

One factor driving prices higher was the short squeeze dynamic: So many traders had bet against, or shorted, Bitcoin that the start of a significant move up was accelerated as investors were forced to buy back their positions to avoid further losses.

More importantly, the rally was exacerbated by a lack of liquidity in the crypto markets. Liquidity has been depressed since the collapse of FTX, which pulled market maker Alameda Research and captured some of the assets of other liquidity providers on the bankrupt platform.

This effectively means that there are fewer buyers and sellers in the market, so when prices pump there are fewer sellers to meet the demand, which helps prices continue to rise. While a lack of liquidity was cheered during Bitcoin’s rally, a price drop could see a reversal of the trend and it could turn ugly.

Still, many in the digital asset space remain confident that the worst of the bear market that dragged Bitcoin down from a November 2021 high near $69,000 is over. The pullback to two-year lows could indicate the formation of a market bottom and capitulation – with all traders who were going to sell having already sold.

“While Bitcoin and crypto more generally fall further from here, we’ve entered what seems to be increasingly seen as a decent buying opportunity for this asset class,” said Anthony Georgiade, co-founder of the Pastel Network blockchain. “Sales have been so dramatic over the past year that the market doesn’t seem to believe there are that many forced sellers left.”

Beyond Bitcoin,

Ether

— the second largest crypto — shed 3% to $1,530. Smaller cryptos or altcoins were also weaker, too

Cardano

and

Polygon

down 4% and 5% respectively. Memecoins reversed an isolated mini-rally, with

Dogecoin

falling 6% and

Shiba Inu

7% in the minus.

Write to Jack Denton at [email protected]