The Catalysts for the Downturn
Cryptocurrencies are facing unprecedented and unrelenting pressure on both a micro and macro level. The very principle of crypto was to be decentralised and decorrelated from the wider capital markets, but, in the past few months, we have seen that the two have become intrinsically linked. Some cryptocurrencies are now behaving more like volatile tech stocks, with the recent pullback of Ethereum mirroring the sharp decline in the value of some long-duration tech stocks in the NASDAQ.
On a micro-level, there have been a number of seismic events that have sent shockwaves throughout both retail and institutional investors in crypto assets. The Terra crash and the failed risk management of Celsius and other lending platforms have done little to alleviate the wider climate of fear and uncertainty. Three Arrows Capital was another casualty, failing to pay out their loans at maturity and eventually declaring bankruptcy. These events, along with others, were at least partly responsible for a serious level of institutional deleveraging that saw a sharp increase in the need for liquidity in the lending markets.
What the Institutions Are Doing
Unlike the near-term vision of many retail investors, many traditional institutions hold a long-term bullish sentiment on cryptocurrencies and are willing to hold through short-term fluctuations to benefit from the appreciation in crypto as an asset class. Those who already own crypto will be taking advantage of the discounted price to average down in their positions, as well as putting their assets to work through DeFi projects such as staking or other yield-generating activities. For these institutions, it is less about HODL and more about accumulation; earning more tokens that should then increase in value over a 5-10 year timeframe.
Many institutions that don’t yet own crypto as an asset class have the crypto playbook ready in their drawer; strategies will be in place to mobilise teams once there is a sustainable uptick and change of sentiment in the market, and allocations will be set for their portfolios. It’s very much a finger-on-the-trigger scenario, as the last crypto bull-run brought the asset class well within their sights.
Institutional behaviour is often influenced by the fundamentals, and these have not changed for cryptocurrencies . As an underlying technology, it will eventually succeed. We only need to look at the short-term success of DeFi versus CeFi to see this. It’s been CeFi businesses that have struggled to survive in the latest market turmoil, but DeFi protocols prevailed. We haven’t observed a significant amount of outflow from institutional investors, and it is this enforced illiquidity that has provided something of a safety net in the value of cryptocurrencies and reduced panic selling.
The Role of Institutions in Restoring the Value of Crypto as an Asset Class
Bear markets don’t only offer institutions a lower entry point into cryptocurrencies, they also foster innovation. These are moments in the cycle where we see a huge influx of institutional capital to fund exciting new Web3 projects, as well as the emergence of strong talent to lead these projects. Just look at the past; Ethereum emerged from the crypto winter of 2016, DeFi boomed a few years later after a downturn and, most recently, NFTs have become incredibly popular against the backdrop of the COVID pandemic, although what makes an NFT valuable still remains in dispute.
Institutions have deep pockets, and so can influence wider sentiment with their wider allocation of cryptocurrencies. As mentioned before, they have created a line in the sand where they will buy the dip and hold. They have and will continue to be, the backbone of crypto against the retail investor hype. Institutions have also been integral to the creation and adoption of stablecoins as a currency, which many see as an integral component of cryptocurrencies in the future.
The Future of Crypto as an Asset Class
This is certainly an interesting few months for cryptocurrencies. While we probably won’t see its purchasing power return to the highs of 2021, the fundamentals at a macro level haven’t changed. For the first time ever, we will get to see how crypto performs in a high inflation environment, and it will be interesting to see how sentiment is shaped by the fact that traditional finance is tempered in what it can do to ease the broader economic burden.
Valuation aside, it wouldn’t be surprising to see regulation take a lead role in shaping the future of crypto as an asset class. Regulatory conversation has been kicked into overdrive by the collapse of numerous lending platforms, and we have already seen governing bodies accelerate their timelines to getting rules and regulations signed off. Just look at MiCa as an example; the two-year timeline to find an agreement between all 27 member states was cut down into months.
We see regulation as an important pillar for the long-term health of the crypto industry, and Finoa will continue to be a key player in protecting investor assets. There is also a need for equality though; there are concerns that crypto could become unfairly regulated when compared to fiat currencies. We see this in the regulations set out by MiCa; all crypto transactions are to be scrutinised, regardless of value, whereas anything below the €10,000 threshold in fiat currencies gets a free pass.
The key to regulation will be parity; aligning crypto more closely with traditional finance rather than stigmatising it. It is important to get this right, especially as the adoption of these regulations will happen relatively quickly.
