- Published: 17th Dec, 2022
Investors are continuing to watch the value of their portfolios decline as cryptocurrencies continue their downward slide. That is, those who haven’t sold their stock yet. At the time of writing, the crypto market is now worth $904.9billion, compared to its peak of nearly $3trillion in November 2021, losing nearly 69% of its value.
In the last week, Bitcoin (BTC), the most popular digital currency, fell as low as $17,773 from $24,338, although it rebounded within 24 hours to a value of $20,522. This is still a 15% decrease in value in just a week, nearly 30% if we go back one month.
Given the general downward trend and the volatility that characterizes the crypto industry, speculators are worried that prices may further sink to as low as $15,000. In eight months, the value of bitcoin has fallen by roughly 70% compared to an all-time high of $69,044.77 reached on November 10 (the street.com). The digital currency accounts for 43.1% of the total crypto market valuation, and this is reflected in the near-identical drop in its valuation and that of the crypto market at large. Basically, as Bitcoin goes, crypto goes and the valuation of the market depends on the evolution of Bitcoin.
Why the sudden Crypto crash?
Although crypto price fluctuations are to be expected, the effect of the volatility is difficult for individual investors to deal with. The reasons for the current price fluctuations can be directly linked to huge sell-offs by investors who are panicked because of inflation and fear of recession. The origin of the collapse though, can be linked to the crash of the stablecoin, TerraUSD (UST).
UST is called a stablecoin because pegged to actual currency, in this case, the US dollar, and as such is supposed to be more stable than other cryptocurrencies. UST is itself backed by a cryptocurrency, Luna, and is supposed to have a ratio of 1:1 with the US dollar. Hence, if the value of the UST stablecoin is $0.95, swapping 1 UST for $1 worth of Luna earns a trader $0.05. If UST is worth $1.05, swapping $1 worth of Luna for 1 UST earns the trader $0.05. The crucial thing about this is that the founders of UST set up bitcoin as a failsafe: to protect UST’s 1:1 peg with the dollar, bitcoin would be bought or sold, and the proceeds then used to buy or sell UST. This would then reset the value of UST.
On May 7, nearly $2billion worth of UST was exchanged for Luna. As a result, the system sold the equivalent in bitcoin to re-stabilize the coin to its 1:1 peg. More traders rushed to dump their UST and the system continued to respond by dumping bitcoin. In the week that followed, bitcoin proceeded to lose 25% of its value.
The collapse of the stablecoin was significant enough to warrant political attention. Regulatory charges are placed by the world’s governments that try to regulate cryptocurrencies. President Biden on the 9th of March 2022, recently placed an order on ‘ensuring responsible development of digital assets’ that although does not have any direct effect on cryptocurrencies, gives reasons for concerns at the possible regulations and investigations.
This is particularly worrying because crypto assets, like those on the stock market, are particularly dependent on perception. A major selling point of cryptocurrencies is independence from government interference. The looming possibility of regulation may have led to more holders dumping bitcoin stock, which has only worsened the slide.
Other global factors?
Another major contributor could be the rising global inflation, a phenomenon that is intrinsically linked to energy prices. The Russia-Ukraine war has significantly affected global oil and gas supply, with Russia being one of the world’s largest exporters. The supply instability has caused global oil prices to rise by as much as 62% from the value at the start of the calendar year.
The US Federal Reserve and other central banks, have responded to the rising inflation by raising interest rates. As higher interest rates make it more difficult for people and companies to borrow money, this will cause people to spend less.. This has led to stocks falling precipitously. Apple, for instance, is down nearly 28% from the start of the year. Cryptocurrencies, which are supposed to act as a hedge against inflation by having their prices rise with inflation levels, are already on a slide. It is probable that with people finding it difficult to borrow and needing the cash, more will sell their crypto stock, continuing the slide.
The crypto crash: Why Investors should brace for impact
The crypto crash has shown that cryptocurrencies are still more of a speculative asset than actual currency. They react to the market the way stocks do and are still highly affected by perception. This particular crash has had a lot of real-world effects.
Just like the trading and investment app, Robinhood, froze trading of GameStop stock during the price spike of January 2021, crypto trading platforms are doing the same. The cryptocurrency lending company, Celsius Network froze withdrawals on the 13th of June. The exchange, Binance, also temporarily halted withdrawals. None of these have served to restore confidence in cryptocurrencies, and it is possible that the slide might continue proportionally to inflation.
It is important to keep some positives in mind even with the crash that is currently being experienced. Bitcoin still remains a digital currency that is confidential, simple, eliminates the need for third parties like banks, and promotes international trade because of the absence of exchange rates.
However, it is also imperative, especially for amateur investors, not to forget the events that led us to this point. Whether the answer lies in regulation, time will tell.
