Bitcoin had its best month since 2021 in January, but cryptocurrency isn't ready for a rocket ship rally just yet

More than a year has passed since Bitcoin's best month. More than half of the losses it suffered in 2022 have already been recovered, and some say it's bottomed out. Despite its strong month, some investors aren't necessarily inclined to jump back into crypto.

It may be the best month for bitcoin since October 2021, according to Coin Metrics, and its best January in 10 years. After a decline of 67.06% in 2022, Ether has risen 31% this month following the crypto recovery last summer. 

As a result of its 63.96% drop at the end of 2022, bitcoin is largely playing catch-up. Investor sentiment has been boosted by lower inflation readings and optimism that the Federal Reserve will soon slow its rate hikes to combat inflation. 

According to Callie Cox, U.S. investment analyst at eToro, the bad news and subsequent headlines made bitcoin extra sensitive to good news at the end of last year. Bitcoin might not be ready for another rocket ship rally just yet, though.

It is likely that the Fed will keep rates high until inflation is under control if it stops hiking," she said. A recession could take some time to develop, and we are unsure whether it will materialize. Investments could decline and unemployment could rise, putting pressure on bitcoin."

There are some signs that the bitcoin price has bottomed out at about $17,000 in December; however, the price is still likely to drop in the future. It has been a bad month for crypto lenders, particularly Genesis, which filed for bankruptcy more than a week ago, and its parent company Digital Currency Group. As a result of the Genesis failure, investors are watching for potential second and third order effects. However, the price of oil has continued to rise.

Also, bitcoin transactions across exchanges are recovering, and bitcoin dominance, which measures how much of the crypto market cap bitcoin makes up, has risen as much as 10% since January.

Ayoub said in a recent note that this is the first meaningful increase since Luna's fall in May 2022. "So far, the rise in BTC dominance has been similar to the rally in BTC that marked the bottom of the crypto market in April 2019."

There will be macro challenges in the future

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Greg Magadini, director of derivatives at Amberdata, says the crypto options market is pricing in sustained upside volatility in bitcoin, and anticipates "as many upside shocks as downside shocks, a major departure from 2022." He also stressed the importance of the macro picture in the quest for a bottom.

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The correlation between Bitcoin and traditional risk assets in 2022 is not likely to change, he emphasized. It is therefore still very important for the Fed to determine its future direction.”

Investors will follow the Fed's latest policy update at its conclusion Wednesday following the start of its two-day policy meeting.

In addition to the Federal Reserve, Lyn Alden, founder of Lyn Alden Investment Strategy, is keeping an eye on the Treasury. Treasury general account drawdowns added liquidity to the system in the fourth quarter, offsetting the Federal Reserve's quantitative tightening. 

The Treasury will need to begin refilling its Treasury cash account once the debt ceiling is resolved, likely by early summer, she said, sucking liquidity out of the system. It is probable that bitcoin has bottomed out, but until the Treasury general account cash drawdown is resolved, the market is not out of the woods yet." 

With a 3-12 month view, this zone still presents plenty of risk, but it is an attractive long-term accumulation zone," Alden said.

The eToro's Cox noted that with so much uncertainty left, she focuses on the technical, noting that bitcoin crossed its 200-day moving average in January, going above its own average closing price. It is considered an indicator of an uptrend when the asset hits that mark.

The 200-day indicator has previously given false signals for bitcoin, according to Katie Stockton, the founder of Fairlead Strategies. A more optimistic view is expressed by Cox.

As long as bitcoin holds that line, it could hover above $20,000 for some time to come. Afterward, I expect bitcoin to follow other risk assets for some time to come, depending on what the Fed does with rates and how the economy is doing.