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1. What happened to the price of cryptocurrencies?
After peaking in November 2021, crypto assets lost $2.2 trillion in the next 12 months, with their combined market value down 73%, according to data from tracker CoinGecko. In the past, such collapses, also known as “crypto winters,” have been triggered by events in the industry itself, such as exchange bankruptcies and regulatory crackdowns. It started externally. Central banks have raised interest rates to combat a surge in post-pandemic inflation. This has reduced investor appetite for riskier assets, including crypto.
2. What does it mean?
The collapse has exploded the notion that, by being detached from the fortunes of traditional financial assets, cryptocurrencies enjoy a similar status to gold as a haven in times of economic uncertainty. It came as a shock to pension and sovereign wealth fund managers, as well as millions of smaller investors, who embraced cryptocurrencies in recent years on the belief that currencies are becoming a mainstream asset class. The 2021 crypto rally is on shaky foundations as many investors take on large amounts of debt to bet on digital coins and projects, often using other cryptos as collateral. It turned out to be built. Its interconnectedness extended the impact of high-profile failures.
The biggest explosion involved a so-called algorithmic stablecoin called TerraUSD. This digital token was intended to be pegged to the US dollar using a parallel currency, Luna. It became popular when users of a decentralized finance (DeFi) platform called Anchor were offered a high interest rate of 20% on TerraUSD deposits. The abrupt withdrawal from Anchor caused TerraUSD’s value to drop, and within days, both TerraUSD and Luna went into a death spiral, wiping out about $60 billion in value. Companies that had invested in related tokens and derivatives, such as Three Arrows Capital, went bankrupt, leading to the bankruptcy of others, such as Voyager Digital, which made a huge loan to Three Arrows. In November, there was yet another shock. The collapse of star entrepreneur Sam Bankman-Fried’s crypto empire, including his FTX, one of the largest digital asset exchanges. The platform, which has played a key role in making cryptocurrencies more appealing to mainstream investors, had lax record keeping and a tangled network of poorly centralized affiliated entities. The FTX collapse was still causing aftershocks in January when Genesis Global Holdco LLC, which had cash stuck in FTX, filed for bankruptcy for at least $3.4 billion in unsecured debt. Cryptocurrency lenders suspended withdrawals shortly after FTX was declared insolvent.
4. What were the results?
Critics said many cryptocurrency projects are doomed to failure because they depended in part on delivering unsustainable returns. They likened some high-yield ventures to new forms of Ponzi schemes, using deposits from new investors to fund payments to existing investors. The implosion of FTX and subsequent failure of Genesis highlighted the danger of contagion. A problem in one corner of the industry quickly spread in unexpected ways, causing huge losses elsewhere. All of this could freeze cryptocurrency investments for a while.
5. Where does this take the industry?
Cryptocurrencies were invented in the wake of the 2008 global financial crisis. This has led to a loss of trust in traditional institutions. But a string of scandals in 2022 raises an existential question of whether cryptocurrencies can also be trusted. Many hoped tighter regulation would restore trust. But FTX’s bankruptcy appears to have derailed legislation that Bankman-Fried had been working so hard on. Some DeFi platform operators have opposed it, seeing it as biased towards the interests of large centralized exchanges like FTX. Tighter regulation could ultimately make cryptocurrencies a more stable and respectable investment. What’s not clear is how much of the industry will stand up to the scrutiny that comes with it.
More articles like this are available at bloomberg.com.
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