Crypto Market

FAN YU is an expert in finance and economics and has contributed analyses on China’s economy since 2015. Fan Yu

Is This the Last Crypto Winter?

The forces that drove crypto value lower in 2022 will likely persist

The year 2022 was the worst period on record for cryptocurrencies.

The industry is on life-support. The crypto market has been rocked by scandals, mismanagement, bankruptcies, and potential fraud. Investor sentiment and trust are possibly at the lowest they’ve ever been, even after the Mt. Gox scandal in 2014, when the then-equivalent of $460 million in Bitcoin was stolen by hackers.

This begs the question, will this be the last crypto winter—a prolonged bear market—ever?

Since the beginning of 2022, the total crypto market capitalization has fallen from $2.2 trillion to $850 billion. This represents potentially the biggest burst of a financial bubble ever within a year. In the same span, Bitcoin—the largest crypto asset—has fallen by roughly 65 percent.

The year 2022 witnessed the epic fall of FTX, a large international exchange, and the indictment of its founder and former CEO—and former crypto savant—Sam Bankman-Fried. Two leading crypto lenders, Celsius and BlockFi, have also declared bankruptcy. Last year’s third-biggest stablecoin, TerraUSD, lost all of its value. One of the biggest crypto hedge funds, Three Arrows Capital, also collapsed.

So what will the future hold?

Let’s begin by examining two external factors.

The first one is macro. The forces that have driven crypto value lower this year—aside from potential fraud such as FTX—will likely persist. Interest rates are likely to remain elevated regardless of inflation, putting pressure on all risk assets, including crypto. Money supply will remain tight around the world, reducing liquidity and allocations to speculative asset classes such as crypto. The crypto market’s famed accessibility and liquidity, such as its 24/7 trading, also makes it one of the easiest assets to sell if an investor needs to raise cash.

A second factor is the regulatory regime. Despite the U.S. Securities and Exchange Commission (SEC) announcing charges against Bankman-Fried, the allegations are fraud and misappropriation of client funds. But the SEC isn’t any closer to regulating the industry in substance. Fraud is bad. But such fraud can arise from any industry lacking any regulatory framework.

Will regulation finally come? Market watchers believe so, but it’s been too slow to develop, and the inherent nature of blockchain makes it difficult. However, it needs to start somewhere, potentially among stablecoins, which serve as the plumbing for much of the crypto trading market.

Part of FTX’s issue is its centralized nature. Investors and stakeholders were putting their trust in an institution. By its very definition, a centralized institution could be sabotaged by bad actors. No matter how noble centralized institutions such as FTX, Binance, and Coinbase present themselves, there’s a lack of transparency and risk that their leadership could make a mistake or, worse, commit fraud.

Decentralized finance, decentralized autonomous organizations, and zero-knowledge ecosystems will be the future, claim some industry experts. These protocols run on the blockchain, with published policies and procedures determined by users, as opposed to central authorities, and full transparency. These types of organizations are what crypto was intended to facilitate, not entities such as FTX, which mimicked legacy banks and exchanges.

Many large crypto firms collapsed in 2022, and there’s almost zero contagion across traditional finance. That says something.

Critics believe that the crypto market is a closed loop of self-established investment and lending schemes that entirely drove its recent growth, buoyed by nothing more than hope and marketing. Indeed, Google searches for “Bitcoin” and “crypto” are at multimonth lows (and as an aside: The fact that a financial asset can be measured by Google search popularity is itself comical).

On Dec. 16, crypto-friendly accounting firm Mazars Group indicated that it would pause providing “proof of reserves” work for crypto clients such as Binance and Crypto. com. Armanino, another accounting firm that services crypto clients— and was the auditor for FTX.us—is ditching crypto firms altogether. One can debate the practical value of auditors, but they’re a foundation of any good financial market’s framework and contribute to investor trust.

For crypto, that trust may be depleted—and perhaps permanently.

Many large crypto firms collapsed in 2022, and there’s almost zero contagion across traditional finance. That says something.