Crypto winter: a simplified precis of 2022

Cryptocurrency remains one of the most divisive portfolio investments, with a risk-reward ratio that makes penny shares look like established blue chips. And 2022 has been a special year for crypto, but not in a good way.

And while 2023 is also likely to see significant volatility, it’s worth reviewing the past year to glean clues about the alternative investment’s future trajectory.

Crypto 2021

Crypto’s launch into the public consciousness truly began with onset of the coronavirus pandemic. While the initial panic saw Bitcoin fall by circa 30% in line with most global markets, the crypto then soared to over $68,000 by November 2021. A year later, Bitcoin is changing hands for less than $18,000, and analysts are divided over whether it has further to fall. Of course, 2022 has not been an enjoyable year for investors, regardless of sector.

While the pandemic years saw a combination of quantitative easing, low interest rates, and loose fiscal policy, investors were prepared to buy crypto and other high-risk assets at pace.

Start-up tech stocks and cryptocurrency saw a golden moment. Bitcoin and Ethereum both reached record highs, DeFi protocols grew to record size, the NFT marketplace expanded exponentially, Facebook rebranded to Meta to focus on its Metaverse project, and the total market cap of all 10,000+ cryptocurrencies grew to over $3 trillion.

Mainstream crypto exchanges, including Binance, Coinbase, and FTX, all saw exceptionally strong growth, with many offering what was in hindsight unrealistic yields. New projects, including Terra and its algorithmic stablecoin UST and brother LUNA took the crypto world by storm.

Crypto 2022

Many investors thought that the ‘emergency’ ultraloose monetary policy introduced in the wake of the 2008 financial crisis and exacerbated by the pandemic response would last forever. Accordingly, many borrowed money to enter highly leveraged positions to make their fortunes. Of course, borrowing money to trade in speculative investments rarely ends well.

As pandemic risks weakened by dint of mass vaccination, the mass rush to restart the global economy, exacerbated by the Ukraine War and China’s interminable lockdown cycles, saw inflation skyrocket across the world to decades-highs.

Central banks responded by decreasing the money supply and raising interest rates to highs not seen since 2008. This caused a carrot-and-stick moment for crypto, as investors saw the attractiveness of lower-risk investments improve, while higher-risk ventures reliant on cheap money became even riskier.

By the end of H2 2022, the crypto market had lost $1 trillion in value as investors fled for the safety of traditional hedges, such as the US Dollar and gold, exiting overleveraged positions by choice or by force.

Crypto winter

The fallout has been rapid and, in many cases, disastrous. Terra imploded as the UST stablecoin became detached from its Us Dollar peg, losing investors billions. CeFi institutions came under huge pressure, having lent to hedge funds such as Three Arrows Capital, which then defaulted on these loans causing both hedge funds and their lenders to file for bankruptcy. See Celsius and Voyager: both promised unrealistic returns, and both failed with mass loss of user funds.

But for a few weeks, it did seem like a degree of certainty was returning to the crypto markets. With the largest coins down by more than 50%, many position traders were looking at attractive long-term entry points. This market confidence was primarily driven by market titan FTX, which was lauded with praise after bailing out CeFi lender BlockFi from bankruptcy.

But then disaster struck once again. Allegations surfaced against FTX, its founder Sam Bankman-Fried, and sister company Alameda Research in November, which amongst other things, included the accusation that FTX had not segregated customer deposits from investing capital.

Bankman-Fried is now under arrest in the Bahamas, and FTX’s native token FTT, potentially used as collateral against loans, has fallen from $26 to just $1. The FTX exchange has stopped most withdrawals, and BlockFi has collapsed back into bankruptcy.

However, it’s worth noting that while the evidence appears damning, there has been no convictions and the story is still developing.

2023 crypto spring

One bullish point to note is that the wider crypto case has not been challenged through 2022. The crypto winter has instead been caused by a combination of bad actors and tightening monetary policy. Technical development continues at pace, with a highlight being Ethereum’s Merge, which saw the powerful altcoin transition to an environmentally friendly proof-of-stake blockchain.

And as for the two headwinds for the wider crypto market, many analysts expect interest rates to start to fall in late 2023, with many having already called inflation’s peak.

Moreover, the bad actors in the crypto space are now going to be weeded out, either through lack of easy access to capital or through increasing regulation. The EU and UK has made huge regulatory strides over the year — with the EU having finally agreed a text for the unified licencing regime for exchanges, to be included within its Crypto Regulation framework.

In the US, all eyes are on the court battle between the SEC and XRP token creator Ripple Labs. Fresh from its victory over LBRY, the SEC has been warring with Ripple since 2020, when Chair Gary Gensler accused it of raising $1.3 billion through an unregistered digital asset securities offering.

Interestingly, this case could finally settle the ‘securities or commodities’ question that has been raging through the crypto world; and with the question settled, crypto regulation will set in.

While an SEC victory could severely limit the ability of crypto companies to grow as launching new tokens could become a securities liability, increased regulation could also be the one thing needed to achieve mass adoption, the only one of the six currency requirements the crypto space is lacking.

Indeed, many have called for the SEC and other regulators to allow the bad actors to implode as a warning to investors to stay away from speculative trading. But crypto is bought with fiat, and if the industry’s future is not in the US, the tech breakthroughs will come elsewhere. Given the power of blockchain advances, this is unlikely to be an outcome that the US will want.

Of course, as the world enters a severe global recession, the only thing guaranteed for 2023 is volatility. But crypto investors should be used to that by now.