What is crypto winter? Here are the basics of this period of market cooling.
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In the first half of 2022, the prices of all major cryptocurrencies fell. Now, a handful of crypto-related companies are facing serious financial difficulties, including bankruptcy. This period of market cooling has become known as “crypto winter.”
Unlike terms such as “market correction” or “bear market”, crypto winters do not have a precise definition.
“In general, it’s a period of sustained lower prices,” said Rayhaneh Sharif-Askary, head of investor relations at Grayscale Investments, an asset management firm specializing in digital currencies.
Wherever the threshold is, it is clear that we have crossed it. Here’s why:
- The fall in value was steep: The total value, or market cap, of the largest 100 cryptocurrencies on July 24, 2022 was $1 trillion. That’s a 62% drop from a market cap of $2.7 trillion on November 7, 2021.
- The downturn was widespread and ongoing: As of July 24, 2022, all 100 of the largest 100 cryptocurrencies are worth less than they were nine months earlier.
This crypto winter is different from the last one
The last crypto winter occurred in 2018, when the price of Bitcoin BTCUSD,
fell more than 50% from its all-time high amid a bull market in traditional finance.
The difference between then and now? “This is the first time we actually see lower crypto trading [than before] in a traditional bear market, says Joel Kruger, market strategist at LMAX Group, which specializes in cryptocurrency services for institutional investors. The bear market can make a crypto recovery more challenging.
“As [crypto] has become larger, there has been more sensitivity to the intersection of the traditional financial market and fundamentals, says Kruger.
Read: When will crypto winter end? Bitcoin halvings may not be enough to explain market cycles
The current decline in crypto prices is part of a global selloff in almost all asset classes, rather than anything specific to crypto. However, there are a few cases of crypto-specific problems, such as the collapse of the algorithmic stablecoin TerraUSD (known by the ticker UST USUSD,
) and the sister coin that backed it, called Terra (known by the ticker LUNA LUNAUSD,
). Because Terra sounds so similar to TerraUSD, we will refer to Terra as LUNA in the story. (Note: TerraUSD and LUNA have since been renamed TerraClassicUSD and Terra Classic, respectively. Fortunately, these new but similar names do not appear in this story.)
The collapse of TerraUSD and LUNA
The collapse of TerraUSD and LUNA resulted in $40 billion in investor losses and has had domino effects throughout the crypto industry.
The two coins are related: TerraUSD is a so-called algorithmic stablecoin that promised stability with a reliable price of $1. And LUNA, its companion coin, was expected to function as a more traditional cryptocurrency with the potential for large price increases.
An algorithmic stablecoin combines economics and technology to provide stability to an asset class otherwise known for high volatility. In theory, LUNA’s 1:1 convertibility with TerraUSD, along with TerraUSD’s redemption value pegged at $1, meant that TerraUSD’s price would remain stable. It would be a safe haven for crypto investors much like cash is a safe haven for traditional investors.
This project broke ground in May. LUNA was worth $116 in April. Since May, the price has hovered around $0.0001. Speaking in July at the Bank of England conference, Federal Reserve Deputy Governor Lael Brainard compared it to a classic bank run. The swift demise of LUNA shook individual investors as well as companies with business models that trusted this project to deliver on its promise.
Learn more: Why is UST crashing, LUNA? Collapse of Once $40 Billion Cryptocurrency, Explained
Frozen customer accounts and sudden bankruptcies
While the technology underlying crypto is new, the financial dilemma some crypto companies have recently faced is timeless: if you borrow large amounts of money to make investment bets that don’t pan out, you’ll have trouble repaying the original loan.
“In particular, where we saw the failures were in organizations that focused on centralized lending,” says Sharif-Askary. “So, as in any market, you had leverage that exacerbated market swings.” Or, as Warren Buffet famously wrote, “You only find out who swims naked when the tide goes out.”
The stories below show how quickly the fortunes changed for companies that just months before were seemingly swimming in success.
- Celsius network opened in 2017 and operated much like a bank. Users could deposit crypto and earn interest — up to 17%, according to the company’s website — and Celsius would issue loans against those deposits. (Last year, regulators in several states questioned the legality of Celsius products.) In June 2022, the company prevented its 1.7 million users from withdrawing or transferring funds — valued at $20 billion at their peak. In July, the company filed for bankruptcy. In a court filing, the company stated that its assets had fallen by 80% between March 30 and July 14, 2022.
- Three Arrows Capital, a crypto hedge fund, managed about $10 billion in assets at its peak before crypto price falls left the company unable to repay billions worth of loans. The founders went into hiding after filing for bankruptcy, and their whereabouts remain unknown.
- Voyager Digital, a crypto brokerage service, filed for bankruptcy in July. Prior to this submission, it paused customer withdrawals. The company cited Three Arrows Capital’s failure to make a $350 million loan payment as a primary cause of its financial problems.
Kruger says the problems facing these companies “are management issues, not representative of the asset class. These are people trying to take advantage of a market that is doing well and is overexposed.”
But these events bring into relief the fact that some consumer protections found in traditional financial products — like FDIC insurance, which protects savers in case their bank goes under — are absent in crypto.
Read more: After Tesla sells most of its bitcoin, Elon Musk says he’s open to buying more, even though ‘cryptocurrency is a sideshow’
What does the future hold?
A popular rule of thumb is that withdrawals occur approximately every four years. For some, this regularity is cause for optimism.
“I think a lot of investors we talk to see this as an opportunity,” says Sharif-Askary. “It’s a reminder that leverage in a system can exacerbate losses. It reinforces the importance of diversification.”
The shock of the first price drops may have worn off, but winter has not yet thawed into spring. Sharif-Askary points to a grayscale white paper released in July that says Bitcoin, a proxy for the crypto market, could “see another five to six months of downward or sideways price movement.”
check out Crypto Tracker at MarketWatch
Meanwhile, news of some firms freezing client accounts is a good reminder to do your due diligence when choosing companies to work with, says Kruger, rather than a reason to write off the sector altogether. If you see promises of extremely high yields, he says, “An alarm bell should go off in your stomach.”
Disclosure: The author and editor had no positions in the investments mentioned at the time of original publication.
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Kurt Woock writes for NerdWallet. Email: [email protected].
