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Analysis | Why Another ‘Crypto Winter’ Is Test for Digital Money


This year’s slump in digital assets has been gut-wrenching for those investors who bought in at the peak. Even crypto diehards, while still convinced that the world is on the verge of a blockchain-driven revolution in finance, were left shaken by the market rout. To those still keeping the faith, the “crypto winter” would be like the dotcom bust of the early 2000s — weeding out failing ventures to make room for more promising startups. Others wondered when spring would come. The collapse in November of one of the industry’s biggest exchanges, FTX.com, underscored the risks of assuming the worst was over. 

1. What is a crypto winter? 

It’s 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 peak. Crypto winters usually feature dramatic declines followed by long bouts of weak prices and thin trading volumes. One slump that began in 2018 wiped as much as 88% off the market value of all crypto assets, according to tracker CoinMarketCap. Between their peak in November 2021 and a low-point in mid-June, they fell as much as 71%, wiping out an estimated $2 trillion of market value, according to rival tracker CoinGecko. 

2. What causes crypto winters?

In their short life, crypto markets have become synonymous with exuberant booms and panic-induced busts. Bitcoin lost around two-thirds of its value in 2014, driven partly 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 beyond the world of crypto played a role. When central banks loosened 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 slumped — exploding the idea that they enjoyed a similar status to gold as a refuge 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). That 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 might spread. 

4. Why was it so brutal? 

Even by the industry’s own volatile standards, it was a spectacular rout. 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 implosion of TerraUSD, Celsius and others was a shock for the pension and sovereign-wealth fund managers — and millions of small investors — who embraced crypto in recent years, as well as for venture capitalists who had funneled tens of billions of dollars into crypto startups at astronomical valuations. It turns out that the bull market of recent years was built on shaky foundations because many investors borrowed heavily to wager on digital coins and projects, often using other crypto as collateral. 

5. What was the fallout? 

The harm done to both institutional and small investors has put governments under more pressure to drag crypto into the same orbit as traditional finance, with improved regulatory oversight to avoid more disasters. Critics see the slump as proof 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 businesses laid off staff, including exchanges Gemini Trust and Coinbase Global Inc. and nonfungible token marketplace OpenSea. Investors were 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 huge losses elsewhere. The risks were underlined in November, when a surge in customer withdrawals led to a liquidity crunch at FTX, the exchange founded by star crypto entrepreneur Sam Bankman-Fried. 

6. What’s the outlook? 

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 claimed — decoupled 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 the winter began, prices and trading volumes were still weak and some crypto startups with workable business plans were running out of cash. Many of the crypto miners who play a vital role in ordering transactions on blockchains — the digital ledgers that underpin crypto — were in distress as the value of the tokens they were earning had tumbled and rising energy prices had inflated their power bills. 

Crypto has a history of bouncing back, and some big institutional investors were undeterred by the rout: In August, BlackRock Inc. announced its first-ever fund to enable direct investment in Bitcoin. The 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, ventures that survive the current winter will have fewer competitors and more space to mature and improve their offering. The growing regulatory crackdown, while adding to the near-term uncertainty around crypto, could eventually make it a more respectable, stable asset class. 

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More stories like this are available on bloomberg.com

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