In the first half of 2022, the price of each major cryptocurrency fell. Now, a handful of crypto-related companies are facing serious financial difficulties, including bankruptcy. This market cooling period has become known as “crypto winter”.
Unlike terms like "market correction" or "bear market", crypto winter does not have a precise definition.
"Broadly speaking, this is a period of sustained lower prices," said Raihaneh Sharif-Askari, head of investor relations at Grayscale Investments, an asset management firm specializing in digital currencies.
Wherever the threshold is, it is clear that we have crossed it. That's why:
- The drop in value was steep: The total value or market capitalization of the largest 100 cryptocurrencies on July 24, 2022 was $1 trillion. That's down 62% from a market cap of $2.7 trillion on November 7, 2021.
- The decline was widespread and continues: as of July 24, 2022, all 100 of the top 100 cryptocurrencies are worth less than they were nine months earlier.
This crypto winter is different from the previous one
The last crypto winter occurred in 2018, when the price of Bitcoin fell more than 50% from its all-time high in the middle of a bull market in traditional finance.
The difference between then and now? "This is the first time we've actually seen crypto trading lower [than before] in a traditional bear market," said Joel Kruger, market strategist at LMAX Group, which specializes in cryptocurrency services for institutional investors. A bear market can make crypto recovery more challenging.
“As [crypto] got bigger, there was more sensitivity to the intersection with the traditional financial market and the fundamentals,” says Krueger.
The current decline in crypto prices is part of a global sell-off across almost all asset classes, not something specific to crypto. However, there have been several instances of crypto-specific issues, such as the collapse of the algorithmic stablecoin TerraUSD (known by the ticker UST) and its sister coin that backed it called Terra (known by the ticker LUNA). Since Terra sounds so similar to TerraUSD, we'll refer to Terra as LUNA in the story. (Note: TerraUSD and LUNA have since been rebranded as TerraClassicUSD and Terra Classic, respectively. Fortunately, these new but similar names do not appear in this story.)
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The collapse of TerraUSD and LUNA
The crash of TerraUSD and LUNA resulted in $40 billion in investor losses and had a domino effect throughout the crypto industry.
The two coins are related: TerraUSD is a so-called algorithmic stablecoin, which promises stability with a reliable price of $1. And LUNA, its companion coin, was expected to act as a more traditional cryptocurrency with the potential for large price increases.
An algorithmic stablecoin combines economics and technology to supposedly provide stability to an asset class otherwise known for high volatility. In theory, the 1:1 convertibility of LUNA with TerraUSD, along with the redemption value of TerraUSD fixed at $1, meant that the price of TerraUSD would remain stable. This would be a safe haven for crypto investors, much like cash is a safe haven for traditional investors.
In May, that project fell apart. LUNA cost $116 in April. Since May, the price has hovered around $0.0001. In a speech in July at the Bank of England conference, Federal Reserve Vice Chairman Lyle Brainard compared it to a classic bank run. LUNA's quick demise rattled individual investors as well as companies with business models that relied on the project to deliver on its promise.
Frozen customer accounts and sudden bankruptcies
Although the technology behind crypto is new, the financial dilemma some crypto companies have recently faced is a timeless one: If you're borrowing large sums of money to make investment bets that don't pan out, you're in trouble with the repayment of the initial loan.
"Specifically, where we saw the failures were organizations that focused on centralized lending," says Sharif-Askari. “So, as in any market, you had leverage that exacerbated market swings.” Or, as Warren Buffett famously wrote, “You only know who's swimming naked when the tide is out.”
The stories below highlight how quickly the fortunes of companies that just months before were seemingly swimming in success have changed.
- Celsius Network opened in 2017 and operates very much like a bank. Users could deposit crypto and earn interest — up to 17%, according to the company's website — and Celsius would issue loans against those deposits. (Regulators in multiple states last year questioned the legality of Celsius' products.) In June 2022, the company barred its 1.7 million users from withdrawing or transferring funds — valued at $20 billion at its peak. In July, the company declared bankruptcy. In a court filing, the company said its assets collapsed with 80% between March 30 and July 14, 2022.
- Three Arrows Capital , a crypto hedge fund, managed about $10 billion in assets at its peak, before the fall in crypto prices left the company unable to repay billions in loans. Its founders went into hiding after declaring bankruptcy and their whereabouts are still unknown.
- Voyager Digital , a crypto brokerage service, filed for bankruptcy in July. Prior to this filing, he paused customer withdrawals. The company cited Three Arrows Capital's failure to repay a $350 million loan as the main reason for its financial woes.
Krueger says the problems facing these companies “are management issues, not asset class issues. These are people trying to take advantage of a market that is doing well and they are overexposed.”
But these developments put into relief the fact that some consumer safeguards found in traditional financial products — such as FDIC insurance that protects savers in case their bank fails — are absent in crypto.
What does the future hold?
A popular maxim states that draws happen every four years. For some, this regularity is a reason for optimism.
"I think a lot of investors we're talking to see this as an opportunity," says Sharif-Askari. "It's a reminder that leverage in a system can make losses worse. This reinforces the importance of diversification .
The shock of the initial price drops may have worn off, but winter hasn't yet melted into spring. Sharif-Askari points to a Grayscale white paper published in July that stated that bitcoin, a proxy for the crypto market, could "see another five to six months of downward or sideways price movement."
Meanwhile, news of some firms freezing customer accounts is a good reminder to do your due diligence when choosing companies to work with, says Kruger, not a reason to write off the sector as a whole. If you see promises of extremely high yields, he says, "It should set off alarm bells in your gut."
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Disclosure: The author and editor held no positions in the aforementioned investments at the time of original publication.