Bitcoin had a big drop late last week. Here's what sparked it, and why that volatility can persist

Published Sun, Aug 20 20238:08 AM EDT

Bitcoin's back to its volatile ways after its big move down late last week — but not for the reason investors expected. Volatility has been a defining characteristic of bitcoin in both positive and negative ways, but it's been almost completely absent from the market for several weeks. That was, until Thursday night, when the cryptocurrency suddenly tumbled as much as 9% . Aside from the mismanaged crypto lenders (and FTX) that plagued the crypto market in 2022, the Federal Reserve's inflation-fighting rate hiking campaign played a big part in bitcoin's downward price pressure. Though investors had started to think the Fed was done with rate hikes for the rest of this year, the minutes of the latest FOMC meeting released Wednesday showed central bank sees "upside risks" to inflation that could lead to more increases. That's when bitcoin's decline really began, and the volatility could linger, according to Mark Connors, head of research at Canadian investment fund manager 3iQ. "The volatility will have a persistence if we're going to stay here at an elevated real rate environment," he told CNBC. "We're not surprised when we see a stepwise function in yields, 25 basis points in a month to 4.25% on the 10-year – the highest in the long time. Mortgage rates are higher, the next hanging chads to drop is credit risk defaults." BTC.CM= 5D mountain Bitcoin (BTC) began falling after the July FOMC meeting minutes were released Wednesday. Market observers typically monitor where the benchmark fed funds rate is hovering, but "real rates" account for the difference between nominal rates and inflation indicators. Even if the Fed doesn't raise interest rates anymore, the crypto space seems more focused now on real rates and keeping them elevated to fight inflation. "These are just normal developments that happen when we're stepping into a new rate regime," he said. "This isn't like bad behavior from last year. The centralized, unregistered, unregulated bad actors and fraudsters hiding offshore entities – that was last year." A 'healthy bloodletting' Investors expected volatility would return when regulatory headwinds turned into tailwinds — by seeing an SEC-approved spot bitcoin exchange-traded fund or clear crypto legislation enacted in Congress. That would also usher in the return of liquidity, which left the market after the banking crisis in the spring, and help create a better functioning market. "This is a healthy bloodletting of some of the active trade management and a reminder that we don't have liquidity and of why we need regulation," Connors said. "We need to have more active engaged market makers in this space to absorb and provide liquidity with guidance from developed markets like the U.S." Crypto needs regulatory clarity so institutional buyers can own crypto assets, Connors explained, likening the situation to high-yield debt in the 1980s: It's still a core holding even though it had its own notorious bad actors that've gone away. "The market and institutions own it. It's a stable market because you have long bias market," he said. "If we get clarity … and we get the ability of institutions to just buy … then when you get these downdrafts of 10% or 15%, institutions won't rebalance their 1% to 2% holdings in bitcoin against equities, they'll add more." "When Bitcoin goes up … there'll be selling into people buying it. That's a healthy ecosystem," he added. Having institutions with an established long core holding would act as a stabilizing force for Bitcoin, Connors added. But currently, institutions are one the sidelines until they get clarity from regulators on how they can bring crypto into their business. That's why this summer's bitcoin ETF filings from BlackRock, Fidelity and other institutions are so critical. "Until this gets settled, capital can't go into the space to help provide that shock absorption," Connors said. —CNBC's Jeff Cox contributed reporting.