It’s no secret that 2022 has been a difficult year for global markets.
The U.S. stock market has fallen over 15% in value, bond markets have fallen over 20% and crypto markets have fallen over 50% from their peak in 2021.
Early in 2022, central banks around the world began to raise interest rates in order to slow inflation and decrease the rate of economic expansion. The tightening of monetary and fiscal policies has dramatically decreased investors’ appetite for risk and speculative investment strategies. Many investors have opted to sell or exit speculative asset classes altogether. This macroeconomic pressure has affected traditional asset classes and has put tremendous pressure on emerging asset classes including cryptocurrency.
The economic situation leading into 2022 allowed crypto to shine. Record low interest rates, an expanding money supply and a strong economy all set the stage for record growth, both in price and adoption, in the crypto economy.
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Evidence of crypto interest
Investor interest in crypto was evident as bitcoin (BTC) and ether (ETH) both reached all-time highs, decentralized finance (DeFi) protocols grew to record size, the crypto market cap topped $3 trillion, the non-fungible token (NFT) market grew exponentially and venture capital firms invested in many crypto businesses.
Centralized finance (CeFi) exchanges saw incredible growth as their services offered attractive yields to investors who were not able to find appealing yields in the traditional financial markets. New crypto projects garnered incredible attention and growth, including the Terra ecosystem, headlined by the algorithmic stable coin UST and sister cryptocurrency LUNA.
Investor appetite for risk and speculative asset investments was driven by economic policy that many people believed would continue for years to come. Traders, institutional investors and speculators entered leveraged positions, borrowing money at low rates, which added to the frenzy witnessed in the crypto markets.
Crypto investors retreat
As central banks reversed course, began to decrease market liquidity and raise interest rates, these speculative asset classes started to slow. Because of the increase in interest rates, investors saw opportunities to hold lower-risk investments and earn an attractive yield. As the prices of risk assets began to decrease, the crypto market began to sell off. By the end of the second quarter of 2022, the crypto market cap had fallen over $1 trillion. This severe sell-off was accelerated as leveraged positions began to unwind.
New and exciting projects like Terra, began to implode as traders exited the crypto markets. The UST stablecoin de-pegged from the U.S. dollar. Investors lost billions of dollars in the UST blow-up, and the overall market went under even more pressure.
CeFi intuitions were overleveraged, having lent significant funds to hedge funds such as Three Arrows Capital, which lost a tremendous amount of capital in the sell-off that followed the Terra failure. Three Arrows Capital, along with many other leveraged hedge funds, defaulted on loans owed to many CeFi companies and these CeFi companies were forced to file for bankruptcy protection. User funds held on CeFi platforms were frozen and retail investors were not able to remove their funds. Companies such as Celsius Network and Voyager Digital, which promised attractive yields to users, failed and users lost their funds.
By the end of the summer, crypto markets were showing signs of stabilizing. The leverage in the ecosystem had apparently been purged from the markets and investor confidence began to return to crypto. The CoinDesk Market Index (CMI) rose to a summer high level of $1,092 on Sept. 12. Confidence was returning to the markets, driven by FTX, a large exchange and custodian, which had stepped in to rescue large CeFi lender BlockFi from bankruptcy. The seemingly strong FTX, led by founder Sam Bankman-Fried, continued to invest in crypto companies, bailed out many distressed startups and was seen as the strongest company in crypto.
Confidence in crypto markets continued into the late fall of 2022, until shocking revelations around FTX and sister company Alameda Research came to light in a November CoinDesk article. Binance CEO Changpeng Zhao immediately and publicly expressed concerns around FTX's solvency and ability to sustain its self-issued token, FTT. Traders began to withdraw funds from FTX. The FTT price fell from roughly $26 to $1 in just a few days and FTX paused customer withdrawals.
The previously healthy company was discovered to be insolvent, having commingled customer deposits and funds. FTX filed for bankruptcy protection in late November. The previous bailout of BlockFi was reversed and BlockFi was back into bankruptcy court. Crypto markets crashed. The CoinDesk Market Index plummeted to a low of $795 as investors continued their exodus from crypto markets.
Opportunity for recovery
It is important to note that none of the failures we’ve seen this year have been caused by a failure of the underlying blockchain technology. In fact, technical development has continued in the space, and this year has been a monumental time in the history of many blockchains. Ethereum underwent a successful upgrade in 2022, transitioning from a proof-of-work blockchain to a proof-of-stake blockchain. The tokenomics of Ethereum have also changed significantly, which many people believe will benefit the future of the Ethereum ecosystem.
The failures and bankruptcies seen in 2022 have led many people to call for further regulation in crypto. Fraud, theft, along with irresponsible lending and leveraged trading have created a difficult environment for investors, which many believe would not have been possible with proper government oversight and regulation.
As we move into 2023, investors should be aware that the current macro environment, lack of regulation and confidence in crypto, and unclear regulatory frameworks will continue to put pressure on crypto. While these issues are significant and will not be easy to overcome, blockchain innovation and progress is continuing to grow and the use cases for the technology are continuing to be adopted. It is important for all investors to review their crypto portfolios, their investment thesis behind crypto allocations, and set a plan for proper crypto investment moving forward.