Commentary
“This time is different” is a dangerous phrase in the world of finance.
But for the cryptocurrency market, this time may actually be different. We are in the midst of a “crypto winter,” a term describing a period of very low prices for the nascent digital currencies market.
This crypto winter has been especially severe, with total market capitalization of the market down more than $2 trillion since the all-time highs reached last year. Is this the beginning of the end for what some critics have labeled as “Monopoly” money, or will this be the turning point where the industry matures from here?
How about both are right?
Crypto proponents will point to several past crypto winters as evidence that this winter, too, will pass, and crypto markets will again hit all-time highs. Depending on one’s definition of “crypto winter,” there have been at least five previous periods of severe drawdown, with 2011, 2013–2015, and 2017–2018 as particularly brutal downturns for Bitcoin, the biggest cryptocurrency. And after every winter, the crypto market would recover and reach new all-time highs.
The rebound may already be occurring, as some of the leading cryptocurrencies, such as Bitcoin and Ether, have recovered from recent lows.
But short-term price movements are irrelevant to long-term prognosis. A price recovery could just as likely be a so-called dead-cat bounce as well as a return to all-time highs. Crypto’s longer-term outlook remains unclear.
What is clear, however, is that this is a completely different industry than the one that suffered the last crypto winter, and the winters before that.
Today’s crypto industry is staffed—more than ever—not by technologists or cryptography nerds but by former Wall Street bankers and traders. These refugees fleeing a heavily regulated industry found themselves in a land with very few rules and regulations. And without the shackles of regulators, these investors built up entities by employing huge amounts of debt and invented crypto-based lending programs collectively and loosely termed “DeFi,” or decentralized finance.
The technology behind these programs may be novel and may employ platforms such as blockchain, but conceptually they are no different than high-yield lending. In some cases, the loans are completely unsecured, and in many cases, they are secured and overcollateralized with other assets. The term “assets” is used loosely here, as the collateral can be in the form of cash (fiat money) or other crypto tokens whose value and worth are themselves dubious.
The amount of debt and leverage in the system today is unlike any other period in crypto’s history. So when prices of tokens declined, a cascade of margin calls followed, and funds, lenders, and crypto institutions became forced sellers.
This market downturn—like ones prior to this—wiped out many crypto investors. It also wiped out many crypto and DeFi businesses. But unlike prior downturns, many of these failing businesses are well-known, employed hundreds of people, ran ubiquitous ads, and attracted hefty valuations and capital investments from venture capital firms and traditional financial services firms looking for a beachhead in this newfangled industry.
Let’s list a few examples. DeFi lender Celsius Network, crypto hedge fund Three Arrows Capital, and crypto merchant bank Voyager Digital each declared bankruptcy. Some firms such as DeFi lender BlockFi, exchange KuCoin, brokerage Genesis, and crypto broker Babel each were rumored to be insolvent, reportedly defaulted on debt obligations, or have engaged consultants on restructuring. And countless others, including industry heavyweight Coinbase, have announced layoffs. Put differently, there is industry-wide contagion.
The role of so-called stablecoins also should be examined. They’re cryptocurrencies that, as the name suggests, have a stable value. There are many types of stablecoins, but they collectively provide an invaluable service to the crypto industry by allowing a stable unit of measure and market participants can deposit unused tokens. In other words, their use-case is similar to that of cash in an industry that is heavily regulated and without many on/off-ramps to fiat currencies.
These stablecoins use a variety of means to peg their value—which is outside the scope of this article—but the failure of a major stablecoin called UST (TerraUSD) earlier this year severely destabilized the crypto market and helped usher the eventual collapse of Three Arrows and other industry participants.
The failure of a major stablecoin serving as a foundation of the crypto market is another wake-up call.
All of this leads back to our original thesis. In an unregulated market such as crypto, there inevitably are many scams, entities with shoddy business models, and entities taking excessive risk. Many DeFi networks appear like Ponzi schemes and have no value or utility beyond hype and marketing. Many businesses with legitimate operations and respected leadership will also fail due to their trafficking and transacting of unproven, unregulated, and sometimes worthless tokens.
But it is also a turning point for the industry. Lawmakers at both the state and federal levels are no longer ignoring or turning a blind eye to the risks that the crypto market poses. There’s bipartisan support in Congress to form new laws governing this market. Both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission have brought enforcement measures in recent months. SEC Chairman Gary Gensler has said the crypto industry is “rife with fraud, scams, and abuse.”
So, with a similar outlook as the American “Wild West” at the turn of the 20th century, the cryptocurrency industry will no longer be the same going forward. If there is an industry with innovative businesses and technologies that can survive and thrive going forward, 2022 will be its legitimate inception.
