Can crypto recover from the 2022 crash?
As far as corrections go, the cryptocurrency crash of 2022 was particularly brutal.
By November 2021, the market had risen to a peak value of nearly $3 billion. By June 2022, it had lost over two-thirds as inflationary pressures and a bleak economic outlook spooked investors. Questions were inevitably raised about the role and function of cryptoassets in the wider economy – a debate that pitted passionate supporters against detractors.
Touted as a democratically beneficial alternative to conventional currencies, cryptocurrencies are considered by some to be an alternative to gold, capable of beating stock market downturns and ensuring inflation. But their short history has been plagued by their own volatility.
Skeptics argued for vindication following the rapid crash of 2022 and resulting high-profile failures of stablecoin issuers and crypto-platforms, further eroding confidence. You could go so far as to suggest that there is an inherent and almost irreconcilable tension between the fact that the things that make cryptocurrencies attractive – decentralization and anonymity – also make them risky and difficult to regulate.
But even if some would have you believe that we have reached the end of the road, in my view the story is far from over.
Before the fall
Things have come a long way since the 2008 white paper in which the pseudonymous Satoshi Nakamoto first outlined the idea of a digital currency that could work without financial institutions as intermediaries. Tellingly, the paper was published just weeks after Lehman Brothers collapsed at the height of the financial crisis, shaking public confidence in those who look after our money.
Over the following decade, the crypto asset market smouldered, then boomed, and the anticipation born of a passionate group of supporters soon followed. There were several drivers for this success, ranging from developments in blockchain technology – particularly decentralized finance (DeFi) – to the large amount of investment in crypto businesses – particularly through initial coin offerings and venture capital funding.
A hard winter
This cocktail of investment and rapid growth of the DeFi ecosystem helped drive strong growth. Some of crypto’s more enthusiastic supporters touted digital currencies as immune to the pressures faced by conventional fiat currencies, an ominous mix of rising inflation, but subsequent macroeconomic and geopolitical challenges have proved that claim wrong.
Various market players felt the cold, from crypto exchanges and brokerages to lending and borrowing platforms. Many private and institutional investors, along with venture capital funds, found themselves exposed due to rapidly declining investments and loan defaults. It is my contention that this spiral has unfortunately not stopped – more insolvencies are to be expected.
Even the institutional crypto miners that underpin the most popular proof-of-work blockchains, such as bitcoin, are feeling the pressure of skyrocketing energy costs and lower crypto prices. Many have moved away from their long-standing “hodl” strategies (wait for your life dear) and are selling their earned tokens at an alarming rate. If the miners fail, the consequence will be felt throughout the industry.
There is also a possibility that we may see the harsh winter extended by claims arising in connection with mis-selling and as a result of the stock exchanges stopping trading. Aggrieved parties may claim to have lost due to such a decision because they did not have enough time to pay out or margin calls. Evidence suggests that the number of cases like these is already on the rise.
That said, it is far from clear how and when insolvency will occur. The fact is that different jurisdictions measure financial health differently. Take Australia, for example, which has a concept of insolvent trading which is measured by a company’s ability to pay its debts in fiat terms. Similar concepts exist in Singapore and the UK. For all three jurisdictions, it is unclear how liabilities play out where the assets and liabilities of a company are significant in crypto.
Crucially, the crypto assets themselves will be relevant during insolvency. While their exact status is still being worked out under many legal frameworks, Australia, Singapore, New Zealand and the United Kingdom are all among jurisdictions likely to consider certain types of crypto-assets to be actionable property. Foremost in the mind should therefore be whether a distressed company or third-party custodian has crypto-assets, and whether it is possible to secure them in the event of insolvency.
A promise of spring
Of course, clear skies follow every storm, and the crypto players who have weathered 2022 are alive to the opportunities that arise. One of my colleagues recently noted that we are already starting to see some degree of market consolidation driven by large players snapping up the small ones that don’t have the runway to see it through this crypto winter.
At the same time, the idea of an irreverent and decentralized environment defined by regulation meant for a previous era looks increasingly impractical for large parts of the crypto market. Senior politicians are aware of this. Earlier this year, the deputy chairman of the Federal Reserve emphasized a need to “future-proof [the US] financial stability agenda” and “ensure that the regulatory perimeter includes crypto-financing”. A similar view is held by many other countries.
There is also an important and often missed distinction between cryptoassets and the blockchain technology that underpins them. Distributed ledger technology – of which blockchain is one type – can provide real benefits and will continue to evolve. Ethereum’s recent high-stakes move to a new platform (dubbed “The Merge”) is a striking illustration of this. The second most dominant blockchain underwent a transition from being a hugely energy-intensive “proof of work” system – which relies on powerful connected computers that solve complex puzzles to add new transactions to the blockchain – to “proof of stake”.
This move, which was completed just a few weeks ago, addresses one of the most potent criticisms of the crypto market – its massive energy use at a time of global warming and rising prices. The energy these systems need can be astronomical and is increasing all the time. Bitcoin, for example, currently uses more energy than Argentina.
But this is not just about reducing energy use. For the Ethereum blockchain, The Merge paves the way for radical upgrades that will increase transaction speed and stabilize costs on the platform. In my view, it’s a good test case for an industry moving towards a greener future that will help it move further into the mainstream.
Technology moves on
It would be easy to imagine that institutional lenders – the entrenched financial elite against whom crypto has so often defined itself – would feel a sense of schadenfreude since the crash. But many, including banks, are paying close attention to how the technology develops and the use cases diversify.
The nimblest challenger banks have already begun to capitalize on continued customer demand for crypto, with some registering as crypto-asset firms with regulators in what could be read as a bet that they are here to stay.
With this in mind, the question of whether cryptoassets are reasonable investments or glorified punts may be justified, but also misses the bigger picture. They – and the blockchain technology they run on – are increasingly moving into the mainstream and will continue to reshape the financial landscape. The result is that attention to potential regulation will continue to intensify, as regulators struggle to balance innovation with consumer protection.
The European Union is in the process of implementing a landmark packagethe Regulation on Markets in Crypto Assets (MiCA), which is designed to protect consumers and increase transparency in the European crypto market. At the same time, regulators in Australia have been examining a draft bill to regulate certain cryptoasset providers, while the UK is moving towards regulating cryptocurrencies and stablecoins as part of the government’s plans to make the jurisdiction “a global technology hub for cryptoassets”.
At the end of the day, financial markets move in cycles and we are living through a significant and notable one for crypto. How long it will take to run its course, and what it will look like on the other side, is anyone’s guess. But blockchain technology and cryptoassets will continue to have a role in modern financial ecosystems – there is clearly value in them.
