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Why Another ‘Crypto Winter’ Is Test for Digital Money

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This year’s slump in digital assets has been discouraging for the investors who bought in at the peak. Even crypto diehards, while still convinced that the world is on the brink of a blockchain-driven revolution in finance, have been shaken by the market rout. For those still keeping the faith, the “crypto winter” would be like the dotcom bust of the early 2000s – wiping out failed businesses to make way for more promising startups. Others wondered when spring would come. The collapse in November of one of the industry’s largest exchanges, FTX.com, highlighted the risks of assuming the worst is over.

1. What is a crypto winter?

This is similar to a bear market in other assets. Stocks are in a bear market when a benchmark index falls by at least 20% from its previous high. Crypto winters usually feature dramatic declines followed by long periods of weak prices and thin trading volumes. One slump that began in 2018 wiped out as much as 88% of the market value of all crypto assets, according to tracker CoinMarketCap. Between their peak in November 2021 and a low in mid-June, they fell as much as 71%, wiping out an estimated $2 trillion in market value, according to rival tracker CoinGecko.

2. What causes crypto winters?

In their short lives, crypto markets have become synonymous with exuberant booms and panic-induced busts. Bitcoin lost about two-thirds of its value in 2014, driven in part by the failure of a major crypto exchange. The 2018 slump came amid a regulatory crackdown on so-called initial coin offerings that led to the demise of thousands of newer cryptocurrencies.

3. How did this one happen?

This time, forces outside the world of crypto played a role. As central banks eased monetary policy in response to the coronavirus pandemic, investors piled into blockchain startups and digital assets. Later, as central banks began to reverse course, crypto-assets fell — exploding the notion that they enjoyed a similar status to gold as a haven for investors in times of economic uncertainty. The slump triggered the collapse of the TerraUSD stablecoin (a digital token designed to maintain a peg to the US dollar). This in turn led to the failure of hedge fund Three Arrows Capital, crypto broker Voyager Digital and crypto lender Celsius Network, among others. Prices fell further in the following weeks as investors wondered how far the contagion could spread.

4. Why was it so cruel?

Even by the industry’s own erratic standards, it’s been a spectacular route. Crypto was supposed to have come of age since the days when it was the obsession of a core of “true believers” and shunned by most investors. The collapse of TerraUSD, Celsius and others came as a shock to the pension and sovereign wealth fund managers – and millions of small investors – who have embraced crypto in recent years, as well as to venture capitalists who have poured in tens of billions of dollars. in crypto startups at astronomical valuations. It appears that the bull market of recent years was built on shaky foundations as many investors borrowed heavily to bet on digital coins and projects, often using other crypto as collateral.

5. What was the fallout?

The damage done to both institutional and small investors has put governments under more pressure to drag crypto into the same orbit as traditional finance, with enhanced regulatory oversight to avoid more disasters. Critics see the slump as evidence that crypto-assets are still too risky to have a place in conventional investment portfolios. Even crypto cheerleader Elon Musk took a step back: His electric car company Tesla Inc. sold 75% of its Bitcoin holdings. Many crypto companies have laid off staff, including exchanges Gemini Trust and Coinbase Global Inc. and non-fungible token market OpenSea. Investors have been wary of diving back in too soon, fearing that problems in one part of the industry could spread quickly and in unexpected ways, leading to heavy losses elsewhere. The risks were underlined in November when a surge in customer withdrawals led to a liquidity crisis at FTX, the exchange founded by star crypto entrepreneur Sam Bankman-Fried.

6. What are the prospects?

The 2022 winter gave ammunition to critics who see crypto as a purely speculative investment. It showed that crypto is not – as its proponents often claim – disconnected from the fortunes of traditional financial assets, and can be as vulnerable to rising interest rates as other investments such as technology stocks. Almost a year after winter began, prices and trading volumes were still weak and some crypto startups with workable business plans ran out of cash. Many of the crypto miners who play a vital role in ordering transactions on blockchains – the digital ledgers that underpin crypto – have been in distress as the value of the tokens they earned tumbled and rising energy prices inflated their power bills.

Crypto has a history of bouncing back, and some big institutional investors haven’t been deterred by the rout: In August, BlackRock Inc. announced its first ever fund to enable direct investment in Bitcoin. That same month, hedge fund firm Brevan Howard raised more than $1 billion for a crypto fund. Just as the last downturn led to the emergence of fewer, more powerful businesses, businesses that survive the current winter will have fewer competitors and more room to mature and improve their offerings. The growing regulatory crackdown, while adding to the uncertainty surrounding crypto in the near term, may ultimately make it a more respectable, stable asset class.

For crypto market prices: {CRYP}; for top crypto news: {TOP CRYPTO}.

More stories like this are available on bloomberg.com

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