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Crypto Crash: Why Did Cryptocurrency Fall?

Like many other markets around the world, the crypto market is going through a particularly brutal time.

On the business side, the world’s largest cryptocurrency exchange Coinbase has laid off 18 percent of its employees. At the time, the co-founder cited the current “crypto winter” as signaling an extended period of revenue losses for the company.

But is this a case of partying for crypto asset classes? Or is it just a minor blip in the bear market? Associate Professor Elvira Sojli and Dr. Eric Lim from UNSW Business School explain what is happening in the cryptocurrency market right now – and what the future could hold for crypto.

See also: Can Cryptos Like Bitcoin Ever Be Sustainable?

What is currently happening with cryptocurrency markets?

Elvira Sojli: The cryptocurrency markets have endured one of the worst months and years yet. Its value has fallen, and most of the decline has occurred in the past two months.

This depreciation is not unique to crypto markets (although it is more pronounced here). Currently, they follow what is happening in the stock market in general, where the stock market index SP500 is down 23 percent year to date. All markets are being hit by rising interest rates around the world, making money more expensive.

Experts have also cited the Ukraine-Russia war as a contributing factor to the current market downturn. Photo: Pexels / Алесь Усцінаў

In general, as money becomes more expensive, the opportunity cost of the investment increases. Additionally, the requirements/costs of investing elsewhere are also increasing, prompting investors to move money from the more volatile assets like crypto and stocks into the safer assets like cash and bonds.

Eric Lim: There can be a tendency when it comes to the crypto market to believe that it is disconnected from global or macroeconomic events. For the record, it’s not.

Currently, we see a macro environment where all financial assets are having a bad time. In the USA, the Federal Reserve (Fed) is trying to bring about a global recession by raising interest rates. The last thing investors want to do is fight the Fed over it. This means investors will shed most financial assets and look for safer assets.

Cryptocurrencies have a reputation for being notoriously volatile. Is the Crypto Market Having Its Own Lehman Brothers-Style 2008 Crash?

Elvira Sojli: Investing in cryptocurrencies has been fueled by the plentiful supply of money looking for yield and the expansion of the retail market. And the retail investor market – a global term for the market of low-level investors who invest in the financial markets from time to time but do not have large amounts of resources at their disposal – found the returns very enticing.

A market like this, fueled by new money inflows, user growth, or investor growth without any increase in associated fundamental value, will run out of steam as fewer and fewer new entrants can enter.

This problem is exacerbated when the cost of money and market uncertainty increases, which is what we are seeing in today’s markets.

Eric Lim: Cryptocurrency critics will point to crypto’s volatility and complaints of less-than-ideal behaviors we’ve seen in this space, such as price manipulation, toxic misinformation, tribalism, and excessive risk-taking.

However, as with any frontier technology, the market will always struggle to gauge the value of something like cryptocurrencies. We saw the same behavior during the dot.com era. Sometimes there will be exuberance and sometimes there will be overcorrection. It’s inevitable, and anyone who knows how markets work will know that time and education will reduce that volatility.

But there’s no denying that crypto has its own 2008 GFC moment. Like the collapse of Lehmann Brothers, this stems from the age-old human history of greed, arrogance, and disregard for the responsibilities assigned to specific individuals. In this case, certain platforms have not been transparent with the loans they make and have failed to take sufficient measures to mitigate risks during downturns. As in any investment space, individuals in the crypto space who have made these poor decisions without proper risk management on behalf of managing their clients’ wealth should be prosecuted to the fullest extent of the law.

Now, is this type of situation one that is specific to cryptocurrency? Putting aside their inherent prejudices against crypto, it clearly has nothing to do with the nature of the technology. Any financial market will attract those players who exaggerate and overestimate their ability to absorb risk and are ruthless in managing their clients’ wealth – both in the cryptocurrency markets and in the highly regulated US financial markets.

Cryptocurrency firms Celsius and 3AC have indeed frozen withdrawals for their customers. What does this mean for cryptocurrency trading?

Elvira Sojli: Celsius is a crypto-based “bank-like” company that attracts deposits from cryptocurrency holders by providing high interest rates, which they lend to borrowers willing to borrow in crypto. Celsius wants to attract investors who distrust the banking system.

The problem is that the Celsius “deposits” are not guaranteed by the Federal Deposit Insurance Corporation (FDIC) deposit insurance scheme like regular deposit accounts. If Celsius goes bankrupt, depositors are not protected and their investment is non-recoverable.

Man looking at investments crashes on computer screen.jpg

The cryptocurrency market has seen a downturn over the past few weeks. Photo: Getty

Three Arrows Capital (3AC) is a cryptocurrency-based hedge fund. This is very different from Celsius. Access to hedge funds is restricted to high net worth individuals (with more than $1 million in invested assets).

Cryptocurrency declines have impacted both companies as the value of their invested assets and collateral has halved this year.

Eric Lim: Celsius behaves similarly to money market funds in the US (albeit less regulated), while 3AC employs standard aggressive portfolio management techniques to generate returns for its clients.

You think this sounds familiar? Of course it does! This is because they are simply traditional financial institutions playing the same financial games in crypto markets instead of the traditional financial markets.

So how are cryptocurrency firms freezing access to withdrawals, impacting crypto investors?

Elvira Sojli: With the very large declines of all cryptocurrencies (over 33 percent over the year and at best 57 percent since early 2022), a large chunk of their investments have been wiped out.

In fact, cryptos like Bitcoin are now back to levels last seen in December 2017. Even those who have held Bitcoin since then have little to show for an investment spanning almost five years. If this market continues to consolidate and slide, the hit for retail investors will be pretty big. This will affect their financial stability and future consumption.

Eric Lim: Mainly people will lose money. And I have the utmost sympathy for these individuals who betrayed their trust in the actors who invested poorly in them.

However, note that we have not heard anyone call for the Fed or the government to step in to bail out these financial institutions like we saw in the 2008 crisis. Nobody is asking Satoshi Nakamoto – the mysterious and unknown creator of the first blockchain database – to create more bitcoins or other crypto assets to further devalue the existing assets held by prudent and responsible investors.

Unlike during the 2008 global financial crisis when the banks were bailed out, the general public cannot be blackmailed into footing the bill of a party to which they were not invited. This is the main difference between a financial market with a decentralized nature (like blockchain) and a centralized one.

See also: Can you “die” in real life if the metaverse forbids you?

Does all this cryptocurrency volatility mean more regulation of the space is on the way?

Eric Lim: Even before events unfolded, it was clear that regulations were coming. Rules bring clarity to a space, and the conversation has to start somewhere.

The Lummis-Gillibrand Responsible Financial Innovation Act was published in the US last week. It’s a law that I believe has the right spirit, with its understanding of the urgent need to protect retail and consumers in the crypto space from bad actors coupled with an understanding of the need to allow innovation in the cryptocurrency space to thrive.

When the cryptocurrency market recovers, what will change?

Elvira Sojli: I see that the process of digitization is continuing, but the crypto market is becoming much more consolidated.

Additionally, the use case for digitally distributed ledgers is still very strong in many types of businesses where it is important to verify carbon footprint, provenance and other data. So overall, technology will be ubiquitous in the future and providers of such services will be companies to invest in.

That being said, without a clear business case or connection to a profitable business, cryptocurrencies will have no future. Unless they can offer a more sustainable business model that generates returns.

Eric Lim: Even in these terrible market conditions, those who believe in crypto are still working on its future.

Man holding up a sign that says 'Bitcoin is the answer.jpg'

Some cryptocurrency advocates see the technology as a way to decentralize and democratize the financial system. Photo: Getty

Technology is inspiring others – their ideals have taken root, and it will take more than this current volatility to quell that. The fundamentals of crypto have not changed and still represent individual freedom and self-sovereignty.

While fair-weather individuals who don’t believe crypto has meaning beyond wealth accumulation may be left behind, the cryptocurrency caravan will move on with or without them.

dr Eric Lim is Founder and Director of the UNSW Crypto Clinic and Fintech Lead in the UNOVA Research Lab with a broad interest in cryptocurrencies and blockchain innovations. He can be reached at [email protected] for comments on this matter.

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