Crypto loans — particularly those in decentralized financial apps that don’t require intermediaries like banks — often require borrowers to provide more collateral than the loan is worth, given the risk of accepting such assets. But when market prices deteriorate, loans that were once overcollateralized are suddenly at risk of liquidation — a process that often happens automatically in DeFi and is exacerbated by the rise of traders and bots looking for ways to make quick bucks.
John Griffin, a finance professor at the University of Texas at Austin, said the rise in crypto prices last year was likely fueled by leveraged speculation, perhaps more than in the previous crypto winter. An environment of very low interest rates and ultra-accommodative monetary policy helped pave the way.
“With interest rates rising and lack of confidence in leveraged platforms, this deleveraging cycle is causing these prices to unwind much faster than they rose,” he said. While traditional markets often rely on a slow and steady amount of leverage to grow, that effect is seemingly amplified in crypto due to the way speculation is concentrated in the sector. Regulators are circling the sector, watching for signs of instability that could threaten their child plans to curb crypto. Even rules announced recently have had to change in the wake of Terra’s collapse, with some jurisdictions preparing rules to mitigate the systemic impact of failed stablecoin systems. Any further crypto disruptions could eventually pave the way for stricter regulations, making a rapid market recovery less likely.
Bitcoin hovers around $20,000, losing about 35 percent in June alone.
“There may be some bear rallies, but I don’t see a catalyst to quickly reverse the cycle,” Griffin said. “When the Nasdaq bubble burst, our research found that the smart investors were the first to get out and sell when prices fell, while individuals bought all the way down and lost money all the time. I hope history doesn’t repeat itself, but often it does. “
Now back at around $1 trillion dollars, the crypto market is only marginally above the roughly $830 billion dollars it reached in early 2018 before the last winter kicked in, triggering a downward move that has pushed the market to its depths to as low as about $4 billion. 100 billion, according to CoinMarketCap data. Back then, digital assets were the playground of dedicated retail investors and a select few crypto-focused funds. This time around, the industry has gained a broader appeal to both mom-and-dad investors and hedge fund titans, often prompting regulators to intervene with statements warning consumers of the risk of trading such assets. As an infamous (now banned) advertisement on London’s transport network read in late 2020, “If you see Bitcoin on a bus, it’s time to buy.”
Unlike crypto’s early believers, mass adoption means most investors now view crypto as just another asset class and treat it in much the same way as the rest of their portfolio. That makes crypto prices more correlated with everything else, like technology stocks.
Unfortunately, that doesn’t make most crypto betting any less complicated to understand. While most of the financial world will take a hit in 2022, the crypto market’s recent crash was compounded by its experimental and speculative nature, leaving small-town traders who put their savings into untested projects like Terra with little recourse. were wiped out. And the industry hype machine is roaring louder than ever, leveraging tools like Twitter and Reddit that have been bolstered by new generations of crypto followers. Exchanges have also done their part, with FTX, Binance and Crypto.com all spending on marketing and high profile sponsorships.
Sina Meier, director of crypto fund manager 21Shares AG, said the extreme risk demonstrates exactly why crypto isn’t for everyone. “Some people absolutely should stay away,” she said during a panel discussion earlier this month at Bloomberg’s Future of Finance conference in Zurich. Many private investors “have lost their way, they just follow what they read in the papers. That’s a mistake.”
Before the previous crypto winter, many startups had used initial coin offerings, or ICOs, to raise capital by issuing their own tokens to investors. They suffered when coin prices collapsed because they kept most of their value in that same pool of assets, plus Ether, and it worsened when regulators began tackling ICOs, akin to offering unregistered securities to investors.
“This time it has a different flavor.”
Jason Urban, co-head of trading at Galaxy Digital
This time around, the financing landscape is vastly different. Many startups that have emerged from the latest freeze, such as nonfungible token and gaming platform Dapper Labs, have sought venture capital funding as a more traditional way of raising money. Giants such as Andreessen Horowitz and Sequoia Capital have combined nearly $43 billion into the industry since late 2020, when the latest bull market kicked in, according to data from PitchBook. This means that instead of relying on crypto wealth, some of its biggest players have stockpiled huge reserves of hard currency to get them through the blizzard as they work to grow new blockchains or build decentralized media platforms. On the other hand, the recent end of the bull market means they spent that money much faster than it came in.
This month, Coinbase, Crypto.com, Gemini Trust and BlockFi are among the crypto firms to announce a series of layoffs, citing the general macroeconomic downturn for derailing their previously expanding plans. Coinbase, which had hired some 1,200 people this year alone, is now laying off about the same number of employees in an 18 percent cut in its workforce.
But thanks to the heights crypto reached during the latest boom, there is still a large amount of earmarked funding around Silicon Valley’s treasury compared to previous seasons. Andreessen alumnus Katie Haun debuted her $1.5 billion crypto fund in March, while Coinbase co-founder Matt Huang launched a $2.5 billion vehicle in November. And while VCs may now be more careful about where they put their money, it still has to be spent somewhere.
“None of these companies mature for years,” said Alston Zecha, partner at Eight Roads. “We’ve been spoiled for the past few years to see companies make this amazing advance after six or nine months. When the tide comes in, there will be a lot of people naked.”
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