Living through crypto cycles

The crypto space is going through a protracted bear market — or a “crypto winter.” This post looks at the reasons of the current downturn, previous cycles and positive outcomes.

For over six months now, the crypto market has been on a downward spiral. The flagship cryptocurrency, BTC, has lost about two-thirds of its all-time high of just over $69,000 reached in November 2021. Other prominent cryptocurrencies, such as ETH, have also significantly dipped. The entire crypto market has lost roughly $2 trillion in value.

Overall, downward and upward trends are typical of financial markets where periods of growth — bull runs — alternate with comedowns — or bear markets. And the crypto space is apparently not an exception.

Just like in traditional markets, a crypto market cycle is a period between the peak and the low of a market. What is different for crypto, though, is that cycles could be significantly shorter due to crypto’s volatile nature.

A prolonged bear market is often referred to as a “crypto winter,” and the previous such event occurred around 2017–2018.

Previous cycles

Since the birth of BTC in 2009, the crypto market has gone through several cycles. The most simplistic approach would be to stick to BTC’s value and consider each occurrence when it halved as the middle of a market cycle.

Following that logic, we see BTC halve in 2012, 2016 and 2020, which gives us neat four-year cycles. Reality, however, is a bit more complicated, especially in recent years, when other cryptocurrencies, such as ETH, have come to prominence and the crypto sector at large has become much more interwoven with traditional finance.

Another factor that has most likely had an impact on crypto cycles is innovation in the space. For instance, in 2011 to 2013, BTC’s early-day rallies were largely driven by the emergence of crypto exchanges (today, few remember the names Silk Road and Mt. Gox, which were dominant exchanges at the time, but later collapsed).

The launch of Ethereum in 2015 and the initial coin offering (ICO) craze triggered another rally, as investors pumped large amounts of money into ICO projects, the lion’s share of which never took off.

Finally, the 2021 bull run was largely driven by exponential growth in decentralized finance (DeFi), a new area of crypto that was set to challenge the world of traditional finance.

Reasons behinds the current downturn

Back in December 2021, BTC saw a significant dip from its highs, which was largely attributed to uncertainty over the ramifications of COVID-19 and concerns about its new version, Omicron.

In earlier 2022, an assortment of macroeconomic factors put added pressure on the crypto space. Rampant inflation prompted the US Federal Reserve, as well as central banks in other major countries, to hike interest rates, further squeezing down crypto prices. Symbolically, BTC reached its 18-month low roughly at the same time as US inflation saw its 40-year high.

In the first half of 2022, the stock market kept slumping, and, unlike the previous cycles, crypto prices were pretty much in synch with equity prices. A decline in crypto — treated similarly to other risk assets — coincided with a dip in tech stocks, with ETH and other cryptos also affected. The global economic downturn — exacerbated by the military conflict in Ukraine, rising oil and gas prices and uncertainty about supply chains — brought about further declines in the value of major cryptos.

Another factor that had negative ramifications for the crypto space was regulatory ambiguity all over the world and fears that crypto regulation could be substantially tightened.

Within the crypto space, the collapse of algorithmic stablecoin Terra, which lost its peg to the US dollar and, subsequently, nearly all of its value, came as a major blow. The Terra fiasco triggered a cascade of liquidations, which wiped out a whopping $50 bln and sent ripples across the entire crypto space, triggering heated discussions about the sustainability of uncollateralized algorithmic stablecoins, such as Terra.

The Terra disaster was followed by the collapses of major crypto lending platform Celsius and Singapore-based hedge-fund Three Arrows Capital (3AC), which wreaked havoc in the space again.

3AC suffered from heavy exposure to Terra’s sister coin, Luna, as it failed to meet a margin call from lender BlockFi and saw its positions liquidated. Subsequently, the hedge fund defaulted on a loan from Voyager Digital with a value of over $660 mln and filed for bankruptcy. Voyager Digital followed suit.

These disasters highlighted the fact that many major centralized lenders failed to properly manage their risks, which worsened the downturn in the crypto industry.

Any silver lining?

While the crypto sector is currently in poor shape and no one dares to predict if it could dip any further, not to mention when proper recovery could begin, is there any silver lining?

One thing that could be taken away from the previous bear cycles is that every time the space necessarily recovered and bounced back even stronger. Arguably, the bear phase is a good time to cleanse the space of weaker players and unsustainable business models, while giving stronger players a breather and a chance to come up with new ideas and solutions.

According to a recent report by JPMorgan, the weakest crypto projects — those with high leverage and lower capital levels — are likely to face the biggest challenge. Conversely, projects with healthier finances and stronger tech are likely to survive the meltdown and emerge stronger as soon as the current cycle is over.