What the differences between bear cycles in the cryptocurrency market are, and why the current one is being called the worst in history

How the current collapse of the crypto market differs from previous ones

14.07.2022

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6 min

The world of digital assets is experiencing a phenomenon known as crypto winter. Bitcoin is down 71,4% from its all-time high (ATH) of November 2021. The total capitalization of the crypto market is down 70,5% from its peak — it was over $3 trillion in November 2021 and is only $883,3 billion as of July 14, 2022. In addition, the Fear and Greed Index (F&G) of the crypto market shows extreme investor concern. On June 16, the F&G fell to its lowest point since the COVID-19 pandemic, reaching a value of “7,” which stands for "extreme fear. On July 14, the indicator climbed to “18,” still in the danger range.

The F&G Index measures overall investor sentiment in the market. It is measured on a numerical scale from 0 (extreme fear) to 100 (extreme greed). Various data such as volatility, bitcoin capitalization, market volume, and social media sentiment are analyzed to determine the index.

Volatility is nothing new for cryptocurrencies. Since bitcoin's inception in 2009, there have been six periods of significant price declines (along with other altcoins).

  • June 2011: Bitcoin's price collapsed by 99% of its ATH;
  • August 2012: the digital asset fell 56%;
  • April 2013: bitcoin lost 83% of its high;
  • December 2013: the BTC rate fell 50% from its ATH overnight;
  • December 2018: bitcoin's value dropped 84%.

Financial experts at analyst firm Glassnode called the current crypto downturn the worst in history. For the first time ever, digital assets are trading below the highs of the previous cycle, and most investors continue to suffer losses due to rising inflation, reduced liquidity, and high leverage.

Previous collapses were caused by market cycles, which are often seen in highly speculative asset classes. The December 2013 crash occurred as China banned local businesses from dealing with bitcoin, and the 2018 collapse came just after the one-time collapse of most projects that raised investments through initial coin offerings (ICOs). In all past downturns, the market eventually recovered and cryptocurrency rates became higher than before.

Market collapse in 2022

Several factors contributed to the current crash. Macroeconomic ones include rapid inflation, which caused the US Federal Reserve System (Fed) to tighten monetary policy, and the correlation of the crypto market with the S&P 500 and NASDAQ stock indices. In previous cycles, these factors were absent. Another difference is that in 2017 and 2018, there were no major Wall Street players using high leverage positions.

Experts told GetBlock Magazine how the crypto market will be affected by the publication of earnings reports of major US companies amid the fall of the S&P 500

However, in addition to the differences, there are some similarities between today's collapse and previous ones. The most significant of them is large-scale losses among novice traders, who got into the crypto industry, tempted by the possibility of high profits.

The current crash of the crypto market is caused by the collapse of algorithmic stablecoins, the emergence of centralized finance (CeFi) and decentralized finance (DeFi) schemes, and the collapse of cryptocurrency lenders.

In May, the Terra blockchain ecosystem crashed due to the loss of the dollar peg of the UST algorithmic stablecoin and the collapse of the LUNA token that provides it. This had consequences for companies associated with the project, particularly hedge fund Three Arrows Capital (3AC), which had a large share of the LUNA token in its portfolio. Consequently, 3AC was unable to meet the margin call of cryptocurrency lender BlockFi, and its positions were liquidated. Other lenders, such as Voyager Digital and 8 Blocks Capital, also said the fund was unable to pay margin calls. As a result, both 3AC and Voyager Digital filed for bankruptcy. Thus, the collapse of Terra became a catalyst for a further decline of the entire digital asset market.

Leverage and the further decline of the crypto market

Another reason for the current collapse was the increase in leverage in the crypto market. In 2017, leverage was mainly provided to retail investors through derivatives on cryptocurrency exchanges. When the digital asset market began to decline in 2018, positions opened by retail depositors were automatically liquidated because they were unable to meet margin calls. This had a bad effect on the overall state of the market.

In 2022, crypto funds and credit institutions began to receive leverage from retail depositors. A large number of unsecured or poorly secured loans emerged. This was made possible by a weak risk assessment system. As a result, asset prices collapsed in the second quarter of this year, putting companies in a difficult position. They had insufficient funds to meet margin calls.

Another lending platform that suffered in this bear cycle was Celsius Network. Founded by Alex Mashinsky, the company promised customers 18% per annum for keeping crypto assets on deposit. The platform positioned itself as a crypto bank, promising better terms than traditional financial institutions. However, due to the prolonged bear market, Celsius was forced to freeze withdrawals. The platform began looking for ways to restore liquidity.

Almost a month later, the platform was sued by former Celsius asset manager Jason Stone and his company KeyFi Inc. The plaintiff accused the platform of running a Ponzi scheme. According to Stone, Celsius attracted new investors with claims of 18% per annum to pay off earlier lenders. Thus, when the downturn began, the Ponzi scheme built by the lending platform collapsed. As of July 13, Celsius has settled its liabilities to creditors and returned more than $1 billion in pledged funds. The platform's lawyers formally notified regulators that the company was filing for bankruptcy, involving a financial restructuring.

What is next?

Historically, bear markets have exposed poor investment performance across all asset classes. During the dot-com crash of the 2000s, many Internet companies went bankrupt. The cryptocurrency ICO boom in 2017 led to the launch and trading of various tokens on cryptocurrency exchanges, many of which had no long-term plans for sustainability. The price collapse in 2018 caused many of these unprofitable projects to crash, while other projects and businesses were able to survive and grow during a prolonged bear cycle.

Some see the current crypto collapse as an opportunity. According to billionaire Mark Cuban, the downturn will have a cleansing effect on the digital asset market. He believes that it is when the bearish trend prevails that the industry will see breakthrough applications and technologies emerge. Changpeng Zhao, CEO of the Binance exchange, is of the same opinion and believes that crypto winter is a great time for the company's development. The exchange has already opened 2 000 new jobs, while other major players such as Coinbase, Gemini and Huobi are cutting staff.

It is still unclear when the market for digital assets will finally stabilize. However, it is likely that during this period we will see a similar reduction in the number of projects as in the past.

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