2022 has certainly been an interesting year for crypto. The macro environment that has defined this past year—interest rate hikes, inflation, war, energy concerns, etc.—has affected risk-on assets in all sectors.
Crypto in particular has had an especially difficult year. A number of high-profile bankruptcies and insolvencies resulted in a staggering amount of capital vanishing from markets in a short period of time. Though bear markets are never fun, the scale of some of the losses incurred by the crypto industry this year has some people wondering if 2022 killed crypto.
Although it would be easy to default to the view that crypto is in fact dead, when examining some of the fundamentals that underpin the thesis for crypto, we continue to see progress in this technology that will likely drive innovation in finance over the long-term.
- Unsustainable business models, bad actors, the deep interconnectedness of many large crypto companies, and lack of regulatory oversight resulted in a lot of turbulence in crypto markets in 2022.
- The crypto industry’s growing pains are reminiscent of the ones commercial banking experienced ~100 years ago.
- However, the fundamentals of the asset class are still compelling, and we believe this year is likely a speed bump on the road to further adoption and long-term growth.
How the mighty have fallen
At the end of 2021, crypto markets were experiencing extreme frothiness. The market cap of cryptocurrencies reached $3 trillion with Bitcoin and Ethereum reaching all-time highs of around $ 69,000 and $4,800, respectively. Investor sentiment was bullish, and, for many, there seemed like there was nowhere to go but up. (1)
Companies and protocols such as Terra Luna, Three Arrows Capital, Celsius, BlockFi, Alameda Research, and FTX rose to prominence and seemed poised to lead crypto into 2022.
A year on from those peaks, the story has changed markedly. The crypto market has shrunk by over $2 trillion, (1) while the Crypto Fear and Greed Index, a widely used measure of crypto investor sentiment, has been alternating between “fear” and “extreme fear” since May.
The factors that led to this reversal are complicated. But serious changes to the global macro-economic climate in the first quarter of 2022, including rising interest rates, decades-high inflation, and a war in Ukraine, played a prominent role in exposing the fragility and high-risk practices of many of these projects. No longer able to maintain their business models with abundant cheap cash and credit, many of these large players imploded, resulting in market contagion that deeply shook investor confidence.
The first major domino to fall was the Terra Luna ecosystem in May. Three Arrows Capital, a hedge fund that had about $10 billion in assets in March 2022, went bankrupt in July largely due to high-risk trading strategies. (2) Celsius, one of the world’s largest crypto banks, followed suit a few days later after falling crypto prices and lack of reserves left them $1.3 billion in the red. (3)
Though very significant in their own right, all these falls from grace were probably overshadowed by the bankruptcies of FTX and Alameda research in November. It was a shocking and traumatic revelation for many in the crypto community when Sam Bankman-Fried’s crypto empire collapsed almost overnight. Underneath it all: a shady web of borrowing and lending between his two companies FTX and Alameda Research; misuse of customer funds; and balance sheets relying too heavily on the FTT token, a token SBF created out of thin air to give perks to FTX users. (4)
The ripples of that collapse were immediately felt throughout the industry, most notably with the bankruptcy filing of BlockFi, one of the world’s largest crypto yield platforms. (5)
Zooming out: fundamentals are strong, though innovation can be bumpy road
Despite the volatility that has been the story of crypto markets this year, we feel it is important to stress that it was not a failure of the technologies that underpin Bitcoin and Ethereum that resulted in companies becoming insolvent and people losing their money.
Bitcoin and Ethereum’s blockchains didn’t break. They continued to work as they were supposed to. It was the human-made problems of inadequate regulation, unsustainable business models, poor risk management, and fraud that resulted in the collapses.
The promises of cryptocurrencies—decentralized money, rapid transfers of value, reduction in fees, democratization of wealth accruement, increased earnings for the creator economy—are still on the table. More infrastructure and capabilities exist today than did at the beginning of 2022. Upgrades and enhancements, such as Ethereum’s much anticipated Shanghai upgrade, are continuing to occur. We believe that the pace of innovation and building in core infrastructure will continue, driving long-term growth in this space. One of the key insights from this year’s chaos is the critical importance of having safe, reliable ways to gain exposure to this asset class.
So, we continue to believe in the fundamentals of cryptocurrencies. But the reality is that this asset class is still in its infancy. The products and services that have sprung up around it, are building and innovating on the fly. And there is bound to be undulations in a sector that is so new and developing so quickly.
Though 2022 has been hard, it is important to remember that much of what has been experienced in crypto markets this year has historical precedence.
A look back to the early 20th century reminds us that the investor emotions, poor risk management, and hubris that seemed to be at the core of crypto’s collapse this year are not so much unique to crypto as they are unique to humans.
The crypto collapse of 2022: some historical perspective
In the early 1900s, the U.S. treasury engaged in large-scale purchases of government bonds and allowed banks to hold their government deposits without reserves. This resulted in a rapid growth in the supply of money and credit into the economy, which, in turn led to increased stock market speculation. (6)
In 1907, the bankruptcy of two speculative New York brokerages precipitated a series of bank runs that started in New York, but quickly spread to the rest of the United States. Depositor withdrawals soon highlighted the lack of reserves and risky investment strategies among many banks and trusts, which led to more depositor withdrawals throughout the industry, which led to more insolvencies. (7)
Because there was no Federal Reserve at the time, the industry was saved from total collapse by the joint efforts of New York clearing houses, the U.S. Treasury, and J.P. Morgan & Co. However, the damage had been done: 1908 saw industrial output fall by 17 percent and real GNP fall by 12 percent. (7)
For those who lived through the 2008 financial crisis, the parallels to 1907 are striking. And in turn, anybody who has been front row to what has happened to the crypto industry in 2022 should also spot a recurring theme: cheap, abundant money and credit, opaque company structures, unsound or potentially unethical business practices, and inadequate regulation and backstops.
The point here is that banks and mortgages were and are susceptible to the same human folly and emotions that resulted in the crypto collapse of the last 12 months. And it was only with proper legislation, backstops, and oversight that they were capable of running businesses and providing products that, on the whole, are safe and widely trusted.
Crypto has been called dead before…yet it is still here
If it isn’t particularly clear by now, we don’t believe 2022 killed crypto. Crypto has been declared dead many times before and come back stronger. We do not see any reason to believe that this time will be different.
The fundamentals and underlying infrastructure of crypto still remain and continue to be enhanced. Pricing levels for Bitcoin and Ethereum are well ahead of pre-pandemic levels. However, some of humanities’ flaws continue to be present within the ecosystem. Bad actors have taken advantage of gaps in regulatory frameworks and oversight, just as they have in other financial service sectors before.
For those who continue to believe in the long-term potential of this asset class, it is critical to find safe and regulated ways to gain exposure. That has been our core belief since we launched the world’s first spot Bitcoin ETF and is the bedrock of all our thinking surrounding crypto. So no, crypto is likely not dead, it just needs to be accessed using transparent, trustworthy, and user-friendly products.
-Haan Palcu-Chang, Crypto Specialist
- “Crypto peaked a year ago—investors have lost more than $2 trillion since,” CNBC: https://www.cnbc.com/2022/11/11/crypto-peaked-in-nov-2021-investors-lost-more-than-2-trillion-since.html
- “From $10 billion to zero: How a crypto hedge fund collapsed and dragged many investors down with it,” CNBC: https://www.cnbc.com/2022/07/11/how-the-fall-of-three-arrows-or-3ac-dragged-down-crypto-investors.html
- “The Fall of Celsius Network: A Timeline of the Crypto Lender’s Descent Into Insolvency,” CoinDesk: https://www.cnbc.com/2022/07/11/how-the-fall-of-three-arrows-or-3ac-dragged-down-crypto-investors.html
- “Why did FTX collapse? Here’s what we know,” The New York Times: https://www.nytimes.com/2022/11/10/technology/ftx-binance-crypto-explained.html
- “What does the BlockFi bankruptcy mean for crypto?” Forbes: https://www.forbes.com/advisor/investing/cryptocurrency/blockfi-bankruptcy/
- “Bank Panic of 1907 Definition,” Investopedia: https://www.investopedia.com/terms/b/bank-panic-of-1907.asp
- “The panic of 1907,” Federal Reserve History: https://www.federalreservehistory.org/essays/panic-of-1907
- “The Evolution of Banking Over Time,” Investopedia: https://www.investopedia.com/articles/07/banking.asp
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