Why are cryptocurrency markets collapsing? And the moon? We explain

The cryptocurrency market is witnessing one of its worst selloffs since a market rally in 2020, sparking investor panic and raising questions as to why cryptocurrency prices have been increasingly sensitive to stock market swings.

In particular, stablecoins are in the spotlight. That type of cryptocurrency, as the name suggests, is supposed to have stable value because the tokens are pegged to the value of a currency like the US dollar or a commodity like gold, providing relative isolation from extreme volatility.

The stablecoins also crashed. What’s behind all this? What awaits us for the cryptocurrency market? We spoke to finance and investment experts for a broad overview.

Why are bitcoin and other cryptocurrencies freezing?

Market experts say two main factors are driving the recent cryptocurrency market crash: moves by the US Federal Reserve to fight high inflation and stabilize markets, and the implosion of terraUSD, a type of so-called stablecoin.

  1. Macro economics: To explain the first factor, let’s start with some macroeconomics. In early 2020, the Fed cut interest rates, or the cost of loans, to manage the economic crisis caused by the pandemic, essentially by pumping more money into households and businesses.

    The result across the board has been inflation which has risen to the highest level in the past four decades. Another consequence: Abundant liquidity pushed prices up in most asset classes, including traditional equity markets and cryptocurrency markets, as traders invested their money in anticipation of stronger returns.

    Rising prices mean economic pain for people – as our incomes, for the most part, don’t rise with prices – and threaten economic growth more broadly. For damage control, the Fed raised interest rates by 50 basis points, or half a percentage point, earlier this month, the largest increase in about two decades. The Fed is also reducing the money supply to further curb the flow of inflation and will continue to raise rates in the future.

    High inflation and, in turn, increases in interest rates make investors nervous because they can hold back business growth and affect companies’ earnings, so they can encourage sales. The Standard & Poor’s 500 and Nasdaq stock indices have fallen by more than 20% since the beginning of the year. Meanwhile, the cryptocurrency market’s market cap has more than halved from its peak of around $ 3 billion in November to $ 1.3 billion today, according to data collected by CoinGecko, which analyzes the digital currency market.

    Bitcoin’s price dropped below $ 30,000 earlier this week, for the first time since July. Bitcoin is the largest trading cryptocurrency in the world and accounts for over 40% of the market.

  2. USD land: What has really caught the attention of cryptocurrency watchers now is terraUSD, known by the list name as UST, and its effect on its twin token, moon.

    These are two cryptocurrencies created by the Terra network, a blockchain project developed in South Korea.

What are the moon and UST cryptocurrencies?

Stablecoins, including terraUSD and luna, were touted as a class of cryptocurrencies that, as the name suggests, offered more stability during market volatility.

The value of the UST token is pegged to the US dollar, which means that at all times the value of a UST should be $ 1. If the value falls below one dollar, the coin could be “burned” and exchanged for a moon dollar.

Luna began trading in May 2019 at around $ 3 and hit an all-time high of around $ 116 in April, according to data from CoinGecko, at a time when most other large-cap cryptocurrencies were falling.

Earlier this week, UST broke the peg to the dollar and, for the first time, the value of 1 UST fell to less than a dollar – it plummeted to less than 30 cents.

What happened to Luna? Why is this such a big deal?

When UST’s price plummeted, the big moon holders cashed in, causing the supply of luna tokens to jump and its price to plummet. Moon lost 99% of its value on Thursday.

According to Bloomberg intelligenceLuna’s sharp decline in value seemed like the worst day for a financial product ever and prompted cryptocurrency exchanges to remove the coin from listing, disrupting trading because there was no liquidity in the market.

One possible reason for the severity of this crash is the particular pricing structure of the UST token, said Edward Moya, senior market analyst at OANDA, an exchange platform.

The FSO operates differently from other stablecoins, such as tether, which are backed by a government-backed currency or commercial cards. It is an algorithm-based stablecoin and uses a complicated method, with the help of luna, to ensure that its value is maintained against the dollar.

“Most stablecoins will keep actual assets to function, but UST’s algorithmic solution hasn’t been able to handle the market volatility we’re seeing in bond markets. This led to a widespread panic sale, ”Moya said.

While the USD land price fell to a low of 30 cents, the moon price plunged to $ 0.00001655, from around $ 81 earlier this week. On Thursday evening, Terraform Labs said it has stopped the blockchain behind cryptocurrencies and is “coming up with a plan to reconstitute it.”

The Fed recently flagged concerns related to stablecoins in its semi-annual financial stability report, stating that the fast-growing sector, which makes up about 15% of the total cryptocurrency market capitalization, is vulnerable to racing and its risks could spill over into cryptocurrencies. traditional markets.

Is the cryptocurrency market now moving more like the stock market?

The cryptocurrency market, like the stock market, has been experiencing declines for months. It peaked in November and, with the Fed’s aggressive liquidity tightening signals, all asset markets have corrected.

Market experts note that the correlation between traditional markets and the cryptocurrency market is likely to be at an all-time high – if one plunges, the other will most likely follow suit or vice versa.

Sylvia Jablonski, chief investment officer and chief investment officer of Defiance ETFs, said the correlation with the Nasdaq is 0.82, up from historical levels below 0.5 (on a scale of 0 to 1). In similar terms, both traditional and equity markets are moving in similar directions more than ever, so there is a spillover effect on investor sentiment.

Experts are looking at a stronger correlation between cryptocurrency and tech stocks, which were among the stocks hardest hit in the recent market crash.

Did I think cryptocurrencies were a hedge against inflation?

Some cryptocurrencies, most notably the market giant bitcoin, have been touted as assets whose value would last over time, meaning they would have been a good hedge against inflation.

But as inflation increases, the price of bitcoin has more than halved, making it less attractive to investors during high periods of high prices.

Caleb Franzen, senior market analyst at Cubic Analytics, a big data analytics firm, said he believes bitcoin will continue to act as an inflation hedge for a longer period of time. Some models predict that bitcoin’s value could drop to a range of $ 19,000 to $ 21,000 in the short term, he said, but over the longer span of five to ten years it could prove to be a good hedge.

What happens next?

Is cryptocurrency straight for a moment Lehman? (Lehman Bros. is the large investment bank that went bankrupt in 2008 and was a major player in the financial crisis.)

“Not yet. You can never say never, especially in cryptocurrencies,” said OANDA’s Moya. “While there are potential catalysts, there doesn’t appear to be a systematic risk.”

Franzen believes that a substantial increase in bitcoin’s value could be a precursor to a rise in inflation as happened between March 2020 and November 2021.