The first half of 2022 ushered in a “crypto winter” not seen since 2018. Crypto investors had no safe-haven with bitcoin down -58%, ether down -72%, and broader indices declining in excess of -70%. As a result, the total crypto market cap fell below $1 trillion from its all-time high of $3 trillion in November 2021. In this note we highlight three catalysts behind the first half sell-off and three focus points for the second half.
Tightening financial conditions
Since the onset of COVID, macro factors have been a key driver of crypto returns. Excess liquidity injected into the financial system as a result of COVID catapulted crypto assets in 2020 & 2021. In 2022, stimulus has slowly evaporated as the Federal Reserve (Fed) tightens policy. Crypto in particular — along with other risk assets — have experienced collateral damage.
Crypto as an asset class, with Bitcoin as its leader, emerged from the ashes of the 2008 great financial crisis. Since then, the Fed has embarked on two aggressive rate hike cycles — one cycle peaked in 2018 and the other is ongoing. Concluding a cause-and-effect relationship between Fed policy and crypto prices may be premature given limited crypto history. Perhaps, however, it is not a coincidence that the crypto winters of 2018 and 2022 both occurred during Fed policy tightening regimes.
Equity bear market
So far, 2022 has presented tightening financial conditions, slowing growth, and rising inflation. Our Positive Yet Realistic 2022 outlook recognized many of these potential challenges against the backdrop of above trend economic growth and solid earnings trends. Equities fell into bear market territory and correlations between equities and crypto rose to all-time highs the deeper the equity sell-off became. This supports our position that crypto has been ineffective as a risk diversifier and should best be thought of as a high-risk growth asset.
Stablecoin and DeFi disruption
Stablecoin and decentralized finance (DeFi) sectors suffered unprecedented turbulence in May and June propelling an event-driven sell-off across the entire ecosystem.
Stablecoins, are the unregulated, unregistered, and uninsured crypto version of money market funds. They’re typically collateralized by short-term debt, such as treasury securities, or fiat currencies and account for 14% of the crypto ecosystem. Algorithmic stablecoins whose value is loosely tethered via mathematical formulas became front page news with the May collapse of the $80 billion Terra protocol. Terra’s failure was partly a consequence of the Anchor DeFi staking protocol which offered +19% staking yields leading to a lack of liquidity and proverbial run on Terra’s USD stablecoin contributing to its ultimate failure.
DeFi, at just 2% of the total crypto market cap, was at the epicenter of the June events that shook up the industry. Crypto lending platforms in DeFi operate much like traditional banks by accepting client crypto deposits, paying an interest rate on those deposits, then lending those deposits to crypto investors for a spread above the rates they pay depositors. Celsius, the failed DeFi lending protocol, was unable to meet customer withdrawal demand leading them to eventually halt withdrawals. Contagion led other crypto lenders to limit withdrawals and even forced the liquidation of key collateral assets such as bitcoin. This story is ongoing and is sure to be a future regulatory focus.
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