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The crypto crash has caused a panic among investors and traders. What were once some of the best-performing assets in any market have now shed anything from 70% to 90% of their former value, leaving most buyers in the red. At the same time, sustained losses have threatened numerous platforms and funds with collapse, in turn threatening a contagion effect that could pull prices down even further.
The situation doesn’t look great right now, but there’s nothing like a history lesson to put things into some kind of perspective. And history shows us that the cryptocurrency market has been through significant downturns before, most notably following the 2013-14 and 2017-18 bull markets. But what’s different this time around is that the industry is in a significantly better place, with losses coming not from the mere popping of an overzealous ‘bubble,’ but from macroeconomic conditions that have also dragged down traditional markets.
It’s really important to emphasize that previous market cycles have ended with the popping of a bubble, in the sense of a sudden loss of momentum as new investors dried up. In contrast, the current crypto crash is a little bit different, even if new investors are staying away right now.
For instance, the price of bitcoin reached a then-record high of $19,783 on December 16, 2017. It then proceeded to fall in fits and starts, dropping suddenly to $14,000 by December 22, as investors took profits, before rising a little again and then gradually sinking to around $6,500 by February 2018. It took the rest of the market with it, with Ethereum reaching its record of roughly $1,400 on January 13, before falling under $700 by February 6.
Bitcoin price between late 2017 and early 2019. Source: CoinGecko
Prices fell steeply because they had risen steeply, with cryptocurrencies overbought and then oversold. If you look at articles published around the time of this frenzy, few if no fundamental reasons were given for the downturn since there weren’t any.
At best, some outlets pointed to a ‘crackdown’ on cryptocurrency trading in countries such as South Korea and China. However, new regulations in a small number of nations can hardly account for such a rapid climbdown, particularly when such regulations either didn’t amount to bans (as in South Korea) or came in addition to previous, already-known restrictions (as in China).
In other words, the 2018 crypto crash was the popping of a bubble in the classic sense, meaning that excessive market momentum had quickly dried up. Something similar applies to the 2013-14 bull market, with the only ‘fundamental’ reason for its rapid end being the hacking and closure of the Mt. Gox exchange.
The price of bitcoin between late 2013 and early 2015. Source: CoinGecko
Again, there were attempts to link the selloff to “warnings” issued by the Chinese government, but it’s hard to imagine that the threat of regulation was enough on its own to bring down the market. Something similar applies to the collapse of Mt. Gox since while this undoubtedly did dampen investor confidence (insofar as it caused traders to lose faith in exchange security), other big exchanges were operating at the time, such as Coinbase and Kraken.
Put differently, Mt. Gox could have had an (outsized) effect on the market only if the latter had already been in a bubble and ready to come down upon the slightest suggestion of negativity. Given that the market had been over-exuberant, it was oversensitive to changes in mood, which was why, if they had any effect at all, the whole Mt. Gox and China crackdown issues could pop it.
There are several reasons why the ongoing crypto crash is different from the market cycles we saw in 2014-15 and 2018-19. Yes, it’s more than arguable that the 2020-21 bull market saw much bubble-like behavior (particularly from NFTs and newer altcoins) during its run, but there are fundamental reasons why it has declined. So it’s not simply a matter of momentum ending, and of the supply of new buyers drying.
For one, it’s important to note that the cryptocurrency market has declined steeply at a time when the traditional stock market has declined steeply. The Nasdaq — which tracks big tech stocks — has dropped by 29% in the year to date, while the S&P 500 and Dow have dropped by 22% and 17% respectively.
The Nasdaq (blue), S&P 500 (green), and Dow Jones (red) since the start of 2022. Source: Yahoo! Finance
Such declines have followed macroeconomic fears surrounding inflation and interest rates, which have served to dampen investor confidence. In this context it’s revealing to note that bitcoin’s correlation with the Nasdaw and S&P 500 has increased substantially this year, reaching a high of 0.8 (out of a maximum of 1) in May, around the time its price plunged from nearly $40,000 to just under $30,000.
Put simply, bitcoin and the cryptocurrency market are down, to a large extent, because financial markets, in general, are down. Of course, things have been exacerbated in crypto’s case by systemic contagion, with the collapse of Terra in May having blowback effects on other platforms and firms, which in turn will have blowback of their own.
However, the deep integration of much of the cryptocurrency market and industry testifies to how much more developed it is during this crypto crash than in previous cycles. Indeed, venture capital funding topped $30 billion in 2021, while it has already reached $15 billion so far in 2022. For context, total worldwide fintech funding — of which the $30 billion figure for crypto above is a part — reached $210 billion, making crypto 14.2% of all fintech VC funding.
While there’s undoubtedly still plenty of froth in the industry, such figures highlight just how far crypto has come in the past few years. Compared to previous downtrends, the sector is in a greater position of strength and is better equipped for rising again once macroeconomic circumstances improve. Sure, previous cycles suggest that the current bear market could last at least a year (i.e. ending in early 2023), but when it does end, crypto will be better able to grow.
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