The year of 2022 has become one of frustration for the crypto industry as cryptocurrencies have been falling dramatically since the very end of 2021 and have continued to decline steadily since the beginning of April 2022. The major cryptocurrency, Bitcoin, lost over 65% of its value this year alone hovering between $15,000 and $16,000 per coin.
This is not the biggest slump of Bitcoin as it lost more than 77% during 2018, its lowest level for that year. So, why are digital assets losing so much of their value? There are many reasons of course but there are a few similarities for why this happened for the crypto market in 2021 and 2022. Firstly, the low interest rates of the Federal Reserve (Fed) flooded financial markets with money, boosting most of its sectors.
However, the Fed also started to raise interest rates in 2017. During that year Fed fund rates rose from 0.75% to 1.5%. This was enough for the crypto market to reverse to the downside in late 2017. Secondly, institutional investors entered the crypto market for the first time in 2017 and in December of that year futures on Bitcoin were launched. By an odd coincidence, Bitcoin prices peaked to their highest level just after this launch.
Futures that were designed to calm down the crypto market and bring more stability to prices served only as an instrument of capital redistribution. This happened because investors who entered the crypto market before futures were introduced and who faced high risks sold their cryptos to investors who entered the market after the market became more predictable with futures contracts.
Now, in 2022 we are witnessing interest rates being raised by the Fed. Since March the U.S. monetary watchdog has been raising rates from 0.25% to 4% in November and is unlikely to stop at this point, as it is looking to hit at least 5% next year.
However, even before rates began their upward climb, many analysts and even officials were debating a possible interest rate rise throughout the fourth quarter of 2021.
So, it became clear in early November 2021 that the Fed would start interest rate hikes, while its Chief Jerome Powell univocally pointed to a cut off of the COVID Stimulus program in the middle of December last year. So, institutions began a sell-off in the crypto market in November-December 2021.
A year has passed since then and the interest rate is now at 4% and could hit the pre-crisis level of 5%, where it was before September 2007. The only difference is that rates were going down back then, and now they are on the upward trajectory with no certainty that they could stop at 5%.
A trip down inflation’s memory lane shows that in September 2007 inflation was at 2% year-on-year, hitting its maximum at 5.6% year-on-year in August 2008, and then dropping to the negative zone in the middle of 2009.
Esperio analysts suggest that the nature of the Great Financial Crisis (GFK) 2008-2009 had more to do with the lack of financial regulation of derivatives and compound instruments that were beyond government regulations. Poor corporate governance and excessive debt burdens to households led to a debt crisis in the United States which then rapidly began to spread to other parts of the financial world.
Now financial authorities and the government set the wheels of the upcoming recession in motion after they flooded the global financial system with cheap money to restart the economy after the COVID-19 impact in 2020-2021.
However, this turned out to be a firefight performed by pouring more gasoline onto a hungry fire. So, at that time institution logic came into play to dump risky assets, including stocks and cryptos.
The major difference this time is that the crypto market has largely developed since 2017. There were numerous projects in the crypto industry that were nothing more than nonentities with no assets or capital behind them. Most of the institutional investors that came in the crypto market were offering their clients some services to get into the crypto world, but no large capital was fundamentally involved in developing this segment.
So, when the risk off sentiment hit the market, many of the institutions preferred to withdraw, leaving minor capital inside the digital industry. Most of the investors that continued to support crypto projects in 2022 were venture funds with a high-risk tolerance.
This crisis is expected to be longer than the GFK, so its impact is expected to last for much longer for the crypto world. Large financial institutions that became an engine of the industry would need some time to recover after the crisis. Even if we witness mild consequences, two or three more years are needed for the industry to recover to the state of 2021.
Alex Boltyan, senior analyst of Esperio company
