What’s causing the upcoming crypto winter and how hard will it hit the financial markets? Let’s explore a few possible scenarios
Winter is coming. This time to the crypto industry. Investors and traders prepare for harsh times just like noble families of Westeros prepared for the great final battle.
Crypto winter is a period of market slowdown when prices fall sharply and take years to recover.
The last crypto winter took place in 2017-2018 before the meme coin boom and a rising number of amateur investors promoting wild speculation on cryptocurrencies. At the time when the last winter chills shuddered the already volatile market, crypto traders saw Bitcoin and other major cryptos fall more than 75% from their previous peaks. It took about three years for those assets to return to previous highs.
The first warnings of another potential crypto winter started popping up as Bitcoin (BTC), Ethereum (ETH), Cardano (ADA), Binance Coin (BNB) and Ripple (XRP) crashed last Friday, wiping $1.5 trillion off the combined cryptocurrency market.
The Bitcoin price fell to the six-month-low last week bottoming at $33,184. On Monday, it even briefly plunged below $33,000. Compared to its November peak, the pioneer crypto dropped more than 50%. Ethereum tanked 14% while other altcoins such as BNB, Cardano, and Polkadot all lost up to 18% in a week following Bitcoin’s downward trend.
What does the Fed have to do with the crypto winter?
One of the most significant reasons for the market crash is the policy changes coming from the Fed. Since the start of the coronavirus crisis, the US Federal Reserve known as the Fed maintained the federal funds rate at the lowest possible range of 0 to 0.25%. Such mild conditions were to be kept as long as the economy had fully weathered the effects of the coronavirus. However, with mass vaccinations and trillions in fiscal stimulus, the US economy is quickly rebounding, paving the way for a spike in interest rates in the near future.
Rising inflation has already stimulated the Federal Reserve to accelerate the taper of its bond purchases. Rising yields on Treasury bonds which typically result from the expectations of a more aggressive Fed policy immediately decreased the lofty valuations of innovative companies. The reason is their utmost value lies quite far in the future when their innovative solutions come into widespread use. Thus, in the face of possible faster tapering of Federal Reserve stimulus and higher interest rates, the value of longer-term cash flows fell. As for the crypto, their value is too speculative and the use cases are still relatively scarce. Thus, their prices started falling along with tech stocks.
At the same time, bond market changes didn’t rule out growing inflation, bringing out gloomy predictions. Economists recently polled by Reuters believe the U.S. Federal Reserve will tighten monetary policy at a much faster pace than thought in December. Median forecasts from the poll showed the Fed is likely to raise its key interest rate three times this year, starting in March, by 0.75 to 1.00% by the end of 2022. Traders fear potential interest rate hikes and aggressive monetary tightening from the Federal Reserve will drain liquidity from the crypto market along with high-growth sectors like tech, which benefit from lower rates since companies often borrow funds to invest in their business. Crypto growth is tightly linked to the fintech industry that promotes practical use of cryptocurrencies.
Regulators introduce further crackdowns
In addition to the unfavourable economic conditions, regulators across the globe keep introducing more limitations to the growth of the crypto industry. For instance, Russia proposes banning both the use and mining of cryptocurrencies on its territory. In a report published last Thursday, the Russian central bank said cryptocurrencies carried characteristics of a financial pyramid threatening the financial stability of Russian citizens, warning of potential bubbles in the market. The regulator proposed preventing financial institutions and fintech platforms including crypto exchanges from carrying out any crypto-transactions and working with regulators in countries where crypto exchanges are registered to collect information about the operations of Russian clients. The approximate annual transaction volume of Russian traders is about $5 billion.
Earlier this month, the nationwide Internet blackout in Kazakhstan and the following political unrest hit Bitcoin miners hard. After China banned mining on its territory, Kazakhstan has become the second-biggest Bitcoin mining home after the United States. The national energy problem worsened on Tuesday when a major transmission line was disconnected. A memo from the national grid operator KEGOC said that “the planned supply of electricity to persons engaged in digital mining is completely cancelled” until the end of the month.
The number of countries and jurisdictions that have banned crypto either completely or implicitly has more than doubled since 2018. According to the 2021 summary report by the Law Library of Congress published last November, Egypt, Iraq, Qatar, Oman, Morocco, Algeria, Tunisia, Bangladesh, and China have all banned cryptocurrency. Forty-two other countries, including Algeria, Bahrain, Bangladesh, and Bolivia, have implicitly banned digital currencies by putting restrictions on the ability for banks to deal with crypto, or prohibiting cryptocurrency exchanges.
In addition, the International Monetary Fund (IMF) is repeatedly pressuring El Salvador over its decision to adopt Bitcoin as a legal form of tender. The IMF has recently urged the Central American country to strengthen regulation and supervision over the cryptocurrency.
Furthermore, the US Securities and Exchange Commission (SEC) rejected a filing to list and trade Bitcoin ETF by First Trust Advisors and SkyBridge, the hedge fund founded by former White House communications director Anthony Scaramucci. The proposed fund would have tracked the “spot,” or current, price of Bitcoin. This listing raised hopes of the crypto investors high as its approval would be a major sign of a growing crypto acceptance by global regulators. Instead, the rejection became one of the major reasons for the great Bitcoin sell-off. The SEC decision was the fourth in a row. In November and December 2021 the regulator turned down three spot Bitcoin ETF proposals.
As if all that wasn’t enough, crypto technology has a set of drawbacks, especially when it comes to the early PoW blockchains such as Bitcoin. Firstly, there’s a threat to the environment caused by unsustainable mining. As the deadlines for carbon-neutrality approach, nations across the globe are worried about the energy use of BTC and other altcoins.
Secondly, blockchain technology is hard to scale up and not as decentralised as it claims to be. It requires all members of the network to be able to oversee and verify transactions. According to UBS analysts, the Bitcoin network itself is being centralised as miners, who operate the network, consolidate. Newer blockchains are either fully or partly controlled by companies and entities. Besides, the “proof of stake” model may concentrate the network control in the hands of a few large operators.
What can we expect from the upcoming crypto winter?
Dan Morehead, CEO of investment firm Pantera, also noted that the sector could stay strong this time because the uses for crypto networks such as DeFi apps have ballooned.
At the same time, many analysts do not share the same opinion. For instance, Galaxy Digital founder Mike Novogratz said crypto is likely to stay under pressure for a long while. This initial sell-off may just be a beginning and things could get much worse in the crypto segment.
“I think it could be an ice age,” agreed the Global Head of Asset Allocation Research at Invesco, Paul Jackson. “I think if you take away those conditions that have been created by the Fed … it does change the outlook. Central banks and governments have played a role in jacking up these markets, and as those policies reverse, then I think they will have a role in depressing them.” Prices may stay low for years and many investors will lose interest in crypto.
Whatever the severity of the crypto winter may be, the market may be getting pickier about which cryptos and blockchain companies will survive as liquidity dries up. Venture capital may be getting scarce, as the crypto assets become riskier to invest in.
Nevertheless, so far Bitcoin’s latest collapse isn’t as big as previous long-term corrections registered since 2013. Throughout its history, Bitcoin has experienced losses of 65-68% of its value during a few months. At present, the fall is only around 50%. Therefore, this crypto winter may differ from the previously experienced ones.