There is rarely a lull in the cryptocurrency market, but the storm of 2022 turned out to be stronger than most of the previous ones. Due to a series of crashes, investors lost billions of dollars overnight. Each crash, the loudest of which was the bankruptcy of the FTX crypto exchange, dragged along a wave of new bankruptcies.
These events undermined the confidence in the industry, which appeared due to the loss of faith in traditional financial institutions after the 2008 crisis. Some investors reacted to the bankruptcies with calls for tough regulation. Others blame intermediaries and say the recent turmoil should speed up the move to more decentralized platforms.
1. What happened to the cryptocurrency rate?
Having peaked in November 2021, the total capitalization of crypto assets fell by 73% over the next 12 months, shows the CoinGecko tracker.
In percentage terms, the collapse was less deep than during the “crypto winter” of 2018 (-88%). But he burned far more investor money: over $2 trillion.
If the previous collapses of cryptocurrencies were caused by problems within the industry itself, then the current one began with an external factor: in the fight against the post-pandemic surge in inflation, central banks raised interest rates. This reduced investor appetite for high-risk, high-yield assets, including cryptocurrencies.
2. Why is it important?
The cryptocurrency market crisis has shattered the belief among investors that cryptocurrencies, like gold, have a haven status in times of uncertainty, as they are supposedly not associated with traditional financial assets. That this is not the case came as a shock to pension and sovereign fund executives, as well as the millions of small investors who have become addicted to cryptocurrencies in recent years. They were confident that cryptocurrencies would become the main asset class in the future.
It turned out that the rise in the rate of cryptocurrencies in recent years rested on a shaky foundation: many investors took large loans and invested in tokens and crypto projects, and other cryptocurrencies were often used as collateral. This relationship reinforced the effect of high-profile bankruptcies.
3. What caused the collapse?
The "first sign" was an algorithmic stablecoin called TerraUSD. To peg to the dollar, he used complex automated procedures involving the parent token Luna.
TerraUSD became popular because its related decentralized finance platform, Anchor, offered rates of up to 20% on TerraUSD deposits. The sudden massive withdrawal of funds from Anchor led to a "death spin", which resulted in TerraUSD and Luna losing about $60 billion in value.
Companies that invested in TerraUSD-related tokens and derivatives, such as Three Arrows Capital, went bankrupt. Other companies failed along the chain, such as Voyager Digital, which provided Three Arrows with a large loan.
November saw another shock: the collapse of Sam Bankman-Freed's crypto empire. One of the largest exchanges, his FTX, collapsed. In just a few days, the man who saved other crypto projects and became the face of the industry at industry conferences and Capitol Hill lost a fortune of $15.6 billion. It is believed that FTX went bankrupt trying to bail out Alameda Research, a trading firm owned by Bankman-Fried.
4. What are the consequences of the crisis?
Terra's critics said the platform was doomed to fail because it attracted investors with unsustainably high-interest rates. Some considered Terra and other high-yield Defi projects to be the next reincarnation of financial pyramids, in which early investors receive huge income by attracting new participants.
The collapse of FTX showed that even seemingly reliable crypto businesses can have hidden weaknesses. He also exposed the danger of crosstalk, where problems in one part of an industry spread unexpectedly quickly to others, causing huge losses. All this can slow down investments in cryptocurrencies for some time.
5. What does all this mean for the future of cryptocurrencies?
Cryptocurrencies were invented because people didn't trust Wall Street. But the string of bankruptcies of crypto companies raises an existential question: can cryptocurrencies now be trusted?
Many hoped that confidence would be restored when the state introduced stricter regulation of the market. But the FTX bankruptcy appears to have derailed the regulatory bill that Bankman-Fried had lobbied hard for. This document was opposed by some owners of Defi platforms, who believed that the law only takes into account the interests of large centralized exchanges such as FTX.
Tight regulation could eventually make cryptocurrencies a more stable and respectable asset. It is not yet clear which part of the industry participants will undergo strict control and what consequences their exit from the market will lead to.
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