Crypto loans — particularly those in decentralised-finance apps that dispense with intermediaries like banks — often require borrowers to put up more collateral than the loan is worth, given the risk of accepting such assets. But when market prices sour, loans that were once over-collateralised become suddenly at risk of liquidation — a process that often happens automatically in DeFi and has been exacerbated by the rise of traders and bots hunting for ways to make a quick buck.
John Griffin, a finance professor at University of Texas at Austin, said the rise of crypto prices last year was likely fuelled by leveraged speculation, perhaps more so than in the previous crypto winter. An environment of rock-bottom rates and ultra-accommodative monetary policy helped set the stage.
“With interest rates rising as well as lack of trust in leveraged platforms, this de-leveraging cycle has the effect of unwinding these prices much more rapidly than they rose,” he said. Though traditional markets often rely on a slow and steady amount of leverage to grow, that effect is seemingly amplified in crypto because of how speculation concentrates in the sector. Regulators are circling the sector, watching for signs of instability that might threaten their infant plans to rein in crypto. Even rules that were recently announced have had to change in the wake of Terra’s collapse, with some jurisdictions preparing rules to ease the systemic impact of failed stablecoin systems. Any further crypto failures could ultimately pave the way for tougher rules, making a market rebound any time soon less likely.
Bitcoin is hovering at around $US20,000, having lost about 35 per cent in June alone.
“There may be some bear rallies, but I don’t see a catalyst to reverse the cycle anytime soon,” Griffin said. “When the Nasdaq bubble burst, our research found that the smart investors got out first and sold as prices went down, whereas individuals bought all the way down and continually lost money. I hope history doesn’t repeat itself, but it often does.”
Now back around $US1 trillion, the crypto market is only marginally above the approximately $US830 billion mark it reached in early 2018 before the last winter set in, spurring a downdraft that sent the market to as low as about $US100 billion at its depths, according to CoinMarketCap data. Then, digital assets were the playground of dedicated retail investors and a select number of crypto-focused funds. This time around, the sector has built a broader appeal to both mum-and-dad investors and hedge fund titans alike, causing regulators to frequently intervene with statements warning consumers of the risk of trading such assets. As one infamous (now banned) advert on London’s transport network read in late 2020: “If you’re seeing 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 to everything else, like technology stocks.
Unfortunately, that doesn’t make most crypto bets any less complex to understand. Though most of the financial world is taking a beating in 2022, the recent crypto market crash was amplified by its experimental and speculative nature, wiping out small-town traders who stuck their life savings in untested projects like Terra with little recourse. And the sector’s hype machine is blaring louder than ever, utilising tools like Twitter and Reddit that have been strengthened by new generations of crypto acolytes. Exchanges have also done their part, with FTX, Binance and Crypto.com all spending on marketing and high-profile sponsorships.
Sina Meier, managing director at crypto fund manager 21Shares AG, said that extreme level of risk demonstrates exactly why crypto isn’t for everyone. “Some people should definitely stay away,” she said during a panel discussion earlier this month at Bloomberg’s Future of Finance conference in Zurich. Many retail investors “are lost, they just follow what they read in the newspapers. 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 came crashing down because they had kept most of their value in that same pool of assets, plus Ether, and it worsened when regulators started to crack down on ICOs as akin to offering unregistered securities to investors.
“It’s got a different flavour this time.”
Jason Urban, co-head of trading at Galaxy Digital
This time around, the funding landscape is vastly different. Many startups born out of the last freeze, such as nonfungible-token and gaming platform Dapper Labs, have sought out venture capital funding as a more traditional route to raising cash. Behemoths like Andreessen Horowitz and Sequoia Capital collectively plugged almost $US43 billion into the sector since late 2020 when the last bull market began, according to data from PitchBook. This means that instead of relying on crypto wealth, some of its biggest players actually have vast reserves of hard currency stored to get them through the blizzard as they work on growing new blockchains or building decentralised media platforms. On the other hand, the recent end to the bull market means they’ve been spending that cash much faster than it’s been coming in.
This month Coinbase, Crypto.com, Gemini Trust and BlockFi are among the crypto companies to have announced swaths of layoffs, citing the general macroeconomic downturn for derailing their previously ever-expanding plans. Coinbase, which had hired about 1,200 people this year alone, is now laying off about as many employees in an 18 per cent cut to its workforce.
But thanks to the heights crypto reached in the last boom, there’s still a great amount of earmarked funding sloshing around Silicon Valley’s coffers compared to previous seasons. Andreessen alum Katie Haun debuted her $US1.5 billion crypto fund in March, while Coinbase co-founder Matt Huang launched a $US2.5 billion vehicle in November. And while VCs might be more careful now about where they put their cash, it’s still got to be spent somewhere.
“None of these companies become mature for many years,” said Alston Zecha, partner at Eight Roads. “We’ve been spoiled over the last couple of years of seeing businesses get these amazing up-rounds after six or nine months. As the tide goes out, there’s going to be a lot of people who are found to be naked.”
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