Is the decentralized crypto economy unsustainable?

The year 2022 has become a frustrating year for the crypto industry as cryptocurrencies have been falling dramatically since the very end of 2021 and have continued to fall steadily since the beginning of April 2022. The main cryptocurrency, Bitcoin, has lost more than 65% of its value this year alone ranging between 15,000 and $16,000 per coin.

This is not Bitcoin’s biggest drop as it lost more than 77% during 2018, the lowest level for that year. So why are digital assets losing so much value? Of course, there are many reasons, but there are several similarities as to why this happened for the crypto market in 2021 and 2022. First, the low interest rates of the Federal Reserve (Fed) flooded the financial markets with money, stimulating most of its sectors.

However, the Fed also began raising interest rates in 2017. During that year, Fed funds rates rose from 0.75% to 1.5%. This was enough to turn the crypto market into a bear market in late 2017. Second, institutional investors entered the crypto market for the first time in 2017, and Bitcoin futures were launched in December of that year. By a strange coincidence, Bitcoin prices reached their highest level right after this launch.

Futures that were designed to calm the crypto market and bring more stability to prices served only as an instrument to redistribute capital. This happened because investors who entered the crypto market before the introduction of futures contracts and faced high risks sold their cryptocurrencies to investors who entered the market after the market became more predictable with futures contracts.

Now, in 2022, we are witnessing an interest rate hike by the Fed. Since March, the US monetary watchdog has raised rates from 0.25% to 4% in November and is unlikely to stop at this point, as it wants to reach at least 5% next year.

However, even before rates started to rise, many analysts and even officials were discussing a possible rate hike during the fourth quarter of 2021.

Thus, at the beginning of November 2021, it became clear that the Fed would start raising interest rates, while its head, Jerome Powell, unequivocally indicated the termination of the COVID Stimulus program in mid-December last year. So, institutions started selling off the crypto market in November and December 2021.

A year has passed since then and the interest rate is now 4% and could reach the pre-crisis level of 5%, where it was before September 2007. The only difference is that rates were falling then, and now they are on an upward trajectory with no certainty of stopping at 5%.

A trip down inflation memory lane shows that in September 2007 inflation was 2% y/y, peaking at 5.6% y/y in August 2008, before falling into negative territory in mid-2009.

Esperio analysts suggest that the nature of the Great Financial Crisis (GFK) of 2008-2009. had more to do with the lack of financial regulation of derivatives and complex instruments that were outside of government regulation. Poor corporate governance and excessive household indebtedness led to a debt crisis in the United States that then quickly began to spread to other parts of the financial world.

Now the financial authorities and government have set the wheels of the coming recession in motion after flooding the global financial system with cheap money to restart the economy after the impact of COVID-19 in 2020-2021.

But it turned out to be a showdown with more gasoline on a hungry fire. So, at that time, institutional logic stepped in to ditch risky assets, including stocks and cryptocurrencies.

The main difference this time is that the crypto market has evolved a lot since 2017. There were numerous projects in the crypto industry that were nothing more than nothing with no assets or capital behind them. Most of the institutional investors who came to the crypto market offered their clients some services to enter the crypto world, but big capital was not essentially involved in the development of this segment.

So, when risk sentiment hit the market, many institutions preferred to withdraw, leaving less capital within the digital industry. The majority of investors who continued to support crypto projects in 2022 were venture funds with a high risk tolerance.

This crisis is expected to last longer than GFK, so its impact is expected to last much longer for the crypto world. The large financial institutions that have become the engine of the industry will take some time to recover from the crisis. Even if we witness mild consequences, it will take another two or three years for the industry to recover to the state of 2021.

Alex Boltyan, Senior Analyst at Esperio

The year 2022 has become a frustrating year for the crypto industry as cryptocurrencies have been falling dramatically since the very end of 2021 and have continued to fall steadily since the beginning of April 2022. The main cryptocurrency, Bitcoin, has lost more than 65% of its value this year alone ranging between 15,000 and $16,000 per coin.

This is not Bitcoin’s biggest drop as it lost more than 77% during 2018, the lowest level for that year. So why are digital assets losing so much value? Of course, there are many reasons, but there are several similarities as to why this happened for the crypto market in 2021 and 2022. First, the low interest rates of the Federal Reserve (Fed) flooded the financial markets with money, stimulating most of its sectors.

However, the Fed also began raising interest rates in 2017. During that year, Fed funds rates rose from 0.75% to 1.5%. This was enough to turn the crypto market into a bear market in late 2017. Second, institutional investors entered the crypto market for the first time in 2017, and Bitcoin futures were launched in December of that year. By a strange coincidence, Bitcoin prices reached their highest level right after this launch.

Futures that were designed to calm the crypto market and bring more stability to prices served only as an instrument to redistribute capital. This happened because investors who entered the crypto market before the introduction of futures contracts and faced high risks sold their cryptocurrencies to investors who entered the market after the market became more predictable with futures contracts.

Now, in 2022, we are witnessing an interest rate hike by the Fed. Since March, the US monetary watchdog has raised rates from 0.25% to 4% in November and is unlikely to stop at this point, as it wants to reach at least 5% next year.

However, even before rates started to rise, many analysts and even officials were discussing a possible rate hike during the fourth quarter of 2021.

Thus, at the beginning of November 2021, it became clear that the Fed would start raising interest rates, while its head, Jerome Powell, unequivocally indicated the termination of the COVID Stimulus program in mid-December last year. So, institutions started selling off the crypto market in November and December 2021.

A year has passed since then and the interest rate is now 4% and could reach the pre-crisis level of 5%, where it was before September 2007. The only difference is that rates were falling then, and now they are on an upward trajectory with no certainty of stopping at 5%.

A trip down inflation memory lane shows that in September 2007 inflation was 2% y/y, peaking at 5.6% y/y in August 2008, before falling into negative territory in mid-2009.

Esperio analysts suggest that the nature of the Great Financial Crisis (GFK) of 2008-2009. had more to do with the lack of financial regulation of derivatives and complex instruments that were outside of government regulation. Poor corporate governance and excessive household indebtedness led to a debt crisis in the United States that then quickly began to spread to other parts of the financial world.

Now the financial authorities and government have set the wheels of the coming recession in motion after flooding the global financial system with cheap money to restart the economy after the impact of COVID-19 in 2020-2021.

But it turned out to be a showdown with more gasoline on a hungry fire. So, at that time, institutional logic stepped in to ditch risky assets, including stocks and cryptocurrencies.

The main difference this time is that the crypto market has evolved a lot since 2017. There were numerous projects in the crypto industry that were nothing more than nothing with no assets or capital behind them. Most of the institutional investors who came to the crypto market offered their clients some services to enter the crypto world, but big capital was not essentially involved in the development of this segment.

So, when risk sentiment gripped the market, many institutions preferred to withdraw, leaving less capital within the digital industry. The majority of investors who continued to support crypto projects in 2022 were venture funds with a high risk tolerance.

This crisis is expected to last longer than GFK, so its impact is expected to last much longer for the crypto world. The large financial institutions that have become the engine of the industry will take some time to recover from the crisis. Even if we witness mild consequences, it will take another two or three years for the industry to recover to the state of 2021.

Alex Boltyan, Senior Analyst at Esperio

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