Understanding what’s happening and the macro-environment factors leading to cryptocurrency decline
The month of May brought a bloodbath in the world of crypto. Although all financial markets are undergoing a bearish phase for a while now, things are getting tougher for crypto.
While writing this, the global crypto market cap is at $1.26T compared to $3T in November 2021 as per CoinMarketCap, which is a 65% fall.
Bitcoin’s price is currently $29,494.32 with currently 44.65% dominance and a 56% fall from ATH. Even Ethereum fell under $2,000 for the first time since last year.
The destabilization of a “stablecoin” called TerraUSD acted as the final nail in the coffin. Its sister currency LUNA fell, dragging UST down to pennies sin being a ‘stablecoin’. Attempting to salvage it, $3.5 billion worth of Bitcoin was spent by TerraForm Labs, leading to the sudden injection and crashing of Bitcoin.
There are also rumors of Coinbase going bankrupt and reports of NFTs markets flatlining. Altogether these are raising concerns about whether the crypto market is mirroring the Wall Street sentiments on the upcoming recession.
Note that crypto has seen better days than this. This huge downfall is leaving the investors, crypto community, and developers feeling uneasy. Experts said that rising interest rates, along with weakening economic activity, have created a risk-off environment.
The current scenario
While cryptocurrencies were regarded as being immune to the monetary policy landscapes, changes in the macroeconomic environment do leave a shadow on the crypto market.
Market experts said rising interest rates, inflation worries, and geopolitical crises are behind factors denting the market sentiment for crypto assets, which are now in a bear grip. These are some reasons pushing the early onset of crypto winter, a market condition where the cryptocurrencies’ prices fall significantly below their usual bullish trend.
Reasons pushing the crypto winter
1- Potential Recession and Interest Rate Hikes: The Federal Reserve has raised rates twice this year to target between 0.75% and 1% — up from near 0% amid the pandemic. Inflation in the US is at a 40-year high with prices for goods and services jumping 8.3% in April.
With the Federal Reserve aggressively raising interest rates to try to tamp down inflation, investors are dumping risky assets, including stocks and crypto.
The S&P 500 is down more than 15% this year. The current risk-averse market is now flushing money from crypto into more stable assets, such as treasury bonds. And this is something that crypto has never seen before — mirroring the effects of traditional financial markets.
2- Risk-On Vs. Risk-Off Conditions: During risk-on conditions, investors are inclined toward high-risk -high reward options. Given the geopolitical crisis of Ukrain-Russia, oil price surges, and record-high inflation, investors are staying away from risky assets.
A Goldman Sachs basket of 11 stocks that are especially sensitive to crypto pricing was clobbered by more than 14% recently. Coinbase, the largest U.S. crypto exchange, dropped close to 20%. Silvergate Capital, the regional bank that bought Facebook’s ill-fated crypto technology, Diem, fell 19%. And MicroStrategy, a software company that issued half a billion dollars of junk bonds to buy bitcoin shed an eye-popping 25.6% yesterday.
Owing to this fall on Wall Street, investors are keen to withdraw from crypto and shift back to a risk-off conservative approach.
3- Stablecoin Collapse: Stablecoins serve the purpose to peg to a fiat currency, thus becoming a macroeconomic factor for the whole crypto ecosystem. Wreaking havoc recently was the de-pegging of TerraUST.
Terra is an algorithmic stablecoin, meaning its supply is adjusted through complicated buying and selling to keep its peg to $1. Luna is its sister currency used in the ecosystem to buy and sell assets, and at its peak, was worth more than $100. It was further backstopped by Bitcoin holdings.
However, withdrawals of perhaps billions of dollars from Anchor, a platform that supported the stablecoin, combined with discouraging market sentiment and the drop in bitcoin’s price, Terra lost its peg to the dollar. The negative arbitrage by selling off these bitcoins caused its prices to fall even further.
4- Regulations by institutions and governments: including China’s crackdown on crypto exchanges and Musk’s decision to stop accepting Bitcoin as payment for Tesla. A lot of talking is happening among the governments of US, UK, Europe to regulate the crypto markets, but not much has happened, thus delaying a careful intervention in the interest of investors. A crypto skeptic, Paul Krugman has gone as far to compare bitcoin to the subprime mortgage crisis of the early 2000s and anticipates a plummet, once due regulations are passed.
Blockchain technology and cryptocurrencies have reaped fortunes for people already since the last few years, despite two drastic crypto winters. It should be noted that Internet also expanded preceded by a dot com bubble that led to recession. Similarly, this crypto winter might lead to a prolonged dip in cryptocurrencies, but confidence on innovation will help rebound the market. Just as mentioned in this Y Combinator letter to all founders, VCs and innovators should prepare for the winter, and hopefully bounce back in the near future.