What is the current contagion effect on crypto winter?
The cryptocurrency industry is facing its toughest test yet. A full-blown crypto contagion resulted in multiple bankruptcies across the sector and a crash in cryptocurrency prices.
In these tough times, we should remind ourselves that the crypto industry is resilient. It has come back with strength from multiple bear markets in the past.
The fast pace of innovation and a keen eye for problem-solving are key characteristics of crypto developers, which will come in handy as we address the industry shortcomings exposed by the latest crypto crisis.
For now, we reflect. How has the crypto contagion affected the crypto market? Will any good come of this adversity? What does the future look like?
What is crypto contagion?
The crypto contagion of 2022 is the spread of a financial crisis across the cryptocurrency sector which resulted in the bankruptcies of prominent firms and a plunge in cryptocurrency prices. It started with the de-pegging of the algorithmic stablecoin TerraUSD (UST) in May 2022. Crypto hedge funds and lending firms with oversized exposure to UST were the first to fall.
An interconnected web of loans between crypto firms was a major reason why the contagion snowballed across the sector as distressed firms defaulted on debt repayments.
Due to the nascent nature of the industry, the majority of traditional banks have taken a wait-and-see approach when it comes to lending to the sector. In order to fill this gap, big players within the crypto sector stepped up to play the role of loan providers.
On a positive note, this closed form of lending has prevented the crypto contagion from evolving into a global financial crisis that would have otherwise affected other industries such as traditional banking, real estate, and more.
The crypto-contagion could have been much worse. The industry has already begun rebuilding with better risk management and customer security in mind.
How is crypto contagion affecting crypto winter?
Customer confidence in the crypto industry hit a low in 2022 due to the contagion. There is a lot of pessimism about the future of cryptocurrencies at the moment.
Behind the scenes, developers at centralized crypto firms are working on regaining the trust of customers by introducing new standards such as “Proof-of-Reserves”.
Proof-of-Reserves requires crypto exchanges and lending firms to publish cryptographical proofs about their asset holdings and customer custodial funds. It is designed to make crypto firms transparent about their financial health and to allow customers to make assessments in real-time.
There are also ongoing discussions within the industry about the future of customer funds being secured by specialist custodians working in collaboration with exchanges to prevent hacks, thefts, and misappropriation of customer funds. These are encouraging signs that the industry is learning and evolving.
One thing that the crypto contagion of 2022 has done is attract the attention of authorities concerned about customer protection, money laundering, and terrorism financing.
2022 has already seen US lawmakers introduce new crypto bills such as the Digital Commodities Consumer Protection Act of 2022 in August and the Digital Asset Anti-Money Laundering Act of 2022 in December.
If passed, these bills will give existing market watchdogs, such as the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), the authority to regulate cryptocurrency markets and firms.
The bills are also proposing the introduction of know-your-customer (KYC) requirements to the crypto mining sector and wallet providers, as well as the reporting of transactions from self-custody wallets.
The path of crypto regulation in the US is widely expected to influence the regulatory roadmap in other countries across the world due to the US’s position as a global financial leader.
All in all, the speed of implementation of crypto market regulations is expected to accelerate in 2023. The incoming regulatory wave will make crypto markets a safer place for customers. There is a risk that overbearing regulations may stifle growth and innovation in the sector.
The ongoing crypto contagion elongated the crypto winter by denting price recovery attempts. Each time crypto prices showed signs of a rebound, news of a new bankruptcy emerged.
The crypto market is now showing signs of market capitulation, with speculators and newcomers leaving the market having seen bitcoin and altcoins on a downtrend since the start of 2022.
How long could the crypto winter last? A study of historical bear markets indicates that we may be past the peak bear market phase. According to Arcane Research, the current bitcoin bear market has already lasted for lengths comparable to the previous bear markets of 2014 and 2018.
The blockchain research firm said bitcoin’s peak-to-bottom cycle lasted 407 days in 2014 and 364 days in 364. The 2022 cycle saw bitcoin bottom out at about $15460 in November 2022, after a downtrend of 376 days since hitting an all-time high of $69,000 in November 2021.
There are other dangers still at bay. We need to watch out for signs of weakness in crypto firms with connections to bankrupt companies. The path of US interest rate hikes will continue to play a critical role in the prospects of crypto markets in 2023.
Even before the start of the 2022 crypto winter, industry insiders like Ethereum co-founder Vitalik Buterin said he “welcomed” a crypto winter as it might cleanse the crypto sector of excess leverage, speculative interests, and unsustainable projects.
After the excesses of the 2020-2021 bull run, some might even call this contagious crypto winter a “necessity” to remind ourselves of creating cryptocurrency use cases that will solve real-world problems such as providing financial services to the underbanked, easing international payments, and facilitating faster and cheaper transactions.
Developers at Ethereum led by example by completing Ethereum’s transition to “proof-of-stake” (PoS) from “proof-of-work” (PoW) in the depths of the crypto contagion and bear market.
Ethereum’s PoS transition, in a move better known as “The Merge”, removed the need for the energy-intensive process of crypto mining to verify transactions on its network. According to the Ethereum website, Ethereum's energy consumption was reduced by about 99.95% following The Merge.
Furthermore, The Merge is expected to make the world’s most popular smart contract platform less expensive to use in the future by lowering gas fees on the network.
With industry frontrunners like Ethereum leading the way for better innovation, crypto believers remain optimistic about the future of the cryptocurrency industry despite the ongoing contagion and bear market.
How can crypto market contagion put your investments at risk?
Crypto market contagion can put customer assets at risk due to a plunge in cryptocurrency prices and the bankruptcies of crypto exchanges and lending firms.