Why are the crypto markets crashing in 2022?

With the crypto markets down, Terra’s tumultuous demise and increased talks of an impending recession (not to mention the recent increase in jobless claims), it seems its doom and gloom across almost all markets and continents. 

So why are the markets crashing in 2022? Let’s explore the reasons behind the unpredictable price swings and the biggest topic on the cryptosphere’s lips: the Terra meltdown. We’ll also take a look at the stock market crashes and the recession red flags already waving. 

The Global Financial Situation

The S&P 500 index dipped below 20% this week officially declaring it a bear market, while Nasdaq is down 28% and markets in Europe and China also weakened. The stock market’s recent performance was described by an insider as being “a losing streak as bad as any that investors have seen over the past decade.” These losses are similar to those in 2001 following the burst of the dot com bubble.

Lloyd Blankfein, Goldman Sach's former CEO, went on record to state that there is a “very, very high risk” that America would slump into a recession, with the company estimating a 35% probability of a U.S. recession in the next two years. Morgan Stanley predicted a 25% chance of one in the next twelve months. 

What Is Behind These Market Crashes?

As the world continues its uphill battle against Covid (many countries still facing waves of new variants), there is also Russia’s invasion of Ukraine wreaking havoc on a large number of countries. With sanctions, tensions and boycotts, prices of everything from oil to standard household goods have seen sharp increases in recent weeks. 

On top of that, there are still serious supply chain issues negatively affecting international trade, another lasting consequence of the pandemic. With backlogs still prevalent across major supply chain hubs and shortages of space, workers and equipment, the recent boom in demand cannot be sustained.

With the consumer’s spending power drastically cut, many investors have pulled out of “riskier” assets, crypto in particular. Investors instead are looking to safe haven assets such as the Swiss Franc and government debt. 

The Extent Of The Dip In Crypto Market Prices 

Since the Bitcoin price narrowly missed highs of $68,000 in November 2021 the cryptocurrency has lost over 60% of its value (at the time of writing). In the week before the Terra crash, Bitcoin was trading at $40,000 but a week later had dropped to $28,000. The price of Bitcoin has since recovered to around $30,000. These lows were last seen on 1 January 2021 before the all time high bull run.

Bitcoin isn’t the only cryptocurrency to see such losses, Ethereum almost reached a high of $4,900 before gradually losing over 60% of its market value following the Terra debacle. 

These losses are not only to the biggest cryptocurrency, they have also extended to the likes of Litecoin, Dogecoin, XRP, and Binance Coin. Since retail investors enjoyed the highs of November, the entire crypto market has since lost $1.9 trillion from its highs in March.  

While the markets being down may seem catastrophic, it also poses an excellent time for new or existing crypto investors to enter the market. In the crypto space, dips are celebrated by savvy investors as they provide an opportunity for “cheap” buy-ins. 

Why Are The Crypto Markets Crashing In 2022?

Cryptocurrency market dips are rarely the result of one event (Elon Musk’s Twitter activities provide a rare exception to this rule) and are more often a contribution of several factors. Prices have been on the decline for several weeks now, and market sentiment points toward a prominent crypto winter. 

Several factors were contributing to the declining prices including but not limited to a lack of liquidity within the markets, investors taking too much leverage, and the uncertainty surrounding crypto regulation. However, this snowballed in May when Terra (LUNA) and Terra USD (UST) took a nosedive and dragged the rest of the crypto market with it.

In the second week of May, the Terra ecosystem unraveled as both cryptocurrencies crashed. The stablecoin intended to be pegged to the US dollar went from trading at $1 to $0.30 in a matter of days, while the native coin LUNA suffered a similar fate as it dropped from $87 to $0.10. At the time of writing, it was worth $0.0001121 and the Terra blockchain has officially been halted. 

As investors rushed to liquidate their Terra assets, the platform’s market prices spiraled further out of control and responded poorly to any recovery attempts. This ended up having a knock on effect on the rest of the cryptocurrency market as weak hands quickly liquidated other crypto assets. 

On the bright side (admittedly a very dim light), Ethereum founder, Vitalik Buterin, explained that market dips provide the industry with a “rejuvenation” period. A chance for less sustainable projects (particularly in the development and decentralized finance space) to fall away and the stronger ones to prosper. The asset class is full of innovation, however, periods of rejuvenation are important.

Other Contributing Factors To The Crypto Market Dip

Regulation

Regulatory uncertainty is often overlooked as a contributing factor to cryptocurrency market dips. As countries around the world are working toward creating a legal framework for cryptocurrencies and blockchain technology and how they can effectively integrate into the traditional financial system, less inclined risk-takers are treading carefully. 

As these regulatory bodies work to decide whether cryptocurrencies and stablecoins are securities or not, this creates a considerable amount of tension and anxiety for traders and investors. 

Leverage

As indicated by Michael Sawyer, the pioneer behind the institutional investment movement in 2020plenty of leverage is available offshore.

Recent months have seen tokens being over-collateralized as exchanges offer up to 20x leverage, and with the DeFi space offering up to 100x leverage, this has had a damaging effect on the market. 

Short term effects are presented as volatility while long term effects are price drops and long-term positions being exited, leading to further price drops. This vicious cycle is further spurred by a lack of liquidity. 

Will The Market Ever Recover?

If you’re new to the industry, yes, it absolutely will. One cannot say they’re truly involved in cryptocurrencies without surviving a strong market dip (or several). Dips are part of the economic cycle and should not be feared. While digital currencies are considered "risky assets", it's important to remember that dips are as prevalent in the stock markets.

Historical data shows that stock markets take a little over a year on average to reach the bottom of a bear market, and then roughly two years to recover to previous highs. Based on observations of the 13 bear markets since 1946, recovery can take anywhere from three to 69 months. 

While dips can illustrate strong losses, fight through the temptation to exit your position as when the markets recover your initial value will be reinstated.

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