Crypto crash: Market volatility is putting investors to the test, but crypto enthusiasts believe the asset class has a future
Bitcoin, the original cryptocurrency, continues to be a leading indicator for the industry. It peaked at more than US$68,000 (£55,600) in November 2021, when the total market value of cryptocurrency was close to US$3 trillion. However, in the months since, most major cryptocurrencies have fallen by more than 70%, with bitcoin falling below US$18,000.
Is this just another crash in the volatile cryptocurrency market, or is it the end of this alternative asset class?
Bitcoin was a novel asset when it was first introduced in early 2009. While trading was limited at first, price appreciation drove its value to nearly US$20,000 by late 2017. This occurred as more retail investors were drawn to cryptocurrency as a supposed hedge or safe-haven asset class compared to other asset classes.
And as the market expanded, so did the variety of investment opportunities. Futures and options are common hedging tools in other markets such as oil and the stock market. They are financial contracts to buy or sell an asset or security at a specific price or date. The Chicago Board Options Exchange listed the first bitcoin futures on a regulated exchange in December 2017. In January 2020, Bitcoin options were listed on the Chicago Mercantile Exchange. This period of expansion was capped by the October 2021 launch of the first bitcoin exchange-traded fund (ETF), which provided investors with exposure to bitcoin without the need to purchase it on a crypto exchange.
Increasing crypto acceptance
Simultaneously, the traditional financial sector began to accept cryptocurrency as a legitimate asset class. According to a 2021 study of institutional investors, seven out of ten expect to buy or invest in digital assets in the future. This combination of maturity and acceptance, however, increased the correlation between the stock market and cryptocurrency, causing their safe-haven properties to deteriorate.
In its early days, Bitcoin was primarily disconnected from traditional financial markets. However, as it became "just another asset," the sector became influenced by the same macroeconomic factors that affect traditional markets. The decision by the US Federal Reserve to raise interest rates by 0.75 percent in June to combat rising inflation, the ongoing conflict in Ukraine, and the subsequent rise in oil prices have all weighed on cryptocurrency in recent months. Regulation efforts have also had an impact.
However, macroeconomic issues are not the only ones that have led to the crypto collapse. Stable coin values dropped in May and June of this year, and major cryptocurrency exchange Binance blocked bitcoin withdrawals owing to a "stuck transaction," while lending platform Celsius Network froze withdrawals and transfers due to "extreme" market circumstances.
Users of the public blockchain platform Solana have reportedly voted to temporarily take control of a so-called "whale" account - the platform's largest at around US$20 million - to prevent the account owner from liquidating its positions and driving prices even lower.
These factors have resulted in a loss of investor confidence in the sector. The Crypto Fear Greed Index has nearly reached an all-time low of 9/100, indicating "extreme fear." When bitcoin reached its all-time high in November 2021, the index was at 75/100.
The cryptocurrency outlook
So, what lies ahead for this alternative asset class? The range of opinions is extreme, as one would expect in the cryptocurrency ecosystem. Some see this market correction as an excellent opportunity to "buy the dip." Others believe that this is the end of the cryptocurrency party.
Resolute bitcoiners can always find positive signs in the market, and many use on-chain metrics (trading signals based on data gleaned from public blockchain transactions) to determine when it is a good time to buy. Popular metrics such as market value to realized value (MVRV - a ratio showing current versus average coin prices) have recently suggested that bitcoin is about to enter an accumulation period based on past performance. On the other hand, this could be a sign of confirmation bias, where investors look for signals that confirm their beliefs.
Others argue this is just another in a long line of cryptocurrency bubble bursts - a typical crypto market cycle. Comparisons to the 2000 dot-com crash have been made, but crypto enthusiasts argue that the basic premise of dot-com stocks was correct - that the internet was the future. They believe the same is true for bitcoin, predicting a recovery in the sector.
However, economists have been studying bubbles for centuries, and evidence shows that many assets never recover their nominal price highs after the market bubble bursts. Some of these economists, including former US Secretary of Labor Robert Reich, have compared cryptocurrency to Ponzi schemes that, if not regulated, will eventually collapse.
Certainly, the vision of cryptocurrency as a decentralised asset available on a peer-to-peer network with no entry barriers contradicts recent actions by some platforms, such as the freezing of withdrawals. These moves will enrage cryptocurrency enthusiasts. Furthermore, cryptocurrency's increased correlation to other asset classes is reducing their value as a diversification tool, while growing interest in Central Bank Digital Currencies threatens to further erode crypto's attractiveness to its core investors.
Cryptocurrency faces additional challenges in terms of energy consumption, privacy, and security. It is unclear whether these issues can be resolved without undermining the characteristics that made cryptocurrency popular in the first place. The recent US launch of a short Bitcoin ETF, which allows investors to profit from bitcoin price declines, will allow investors to hedge their positions and trade against bitcoin.
Investing in cryptocurrency is like riding a rollercoaster, with large gains followed by sharp drops. Volatility is rampant, bubbles and crashes are common, and opinions on environmental, ethical, and social benefits differ. The market's major correction has tested even the most ardent crypto-enthusiast. Buckle up, this story isn't over yet.
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