After a Fall, Crypto Winter Sets In

Cryptocurrencies hit a rough patch in 2022, with prices falling and some companies facing serious financial issues.
Aug 1, 2022

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In the first half of 2022, the price of every major cryptocurrency dropped. Now, a handful of crypto-related companies are facing serious financial difficulties, including bankruptcy. This period of market cooling has become known as "crypto winter."

Unlike terms such as “market correction” or “bear market,” crypto winter doesn’t have a precise definition.

“Generally speaking, it’s a period of sustained lower prices,” says Rayhaneh Sharif-Askary, head of investor relations at Grayscale Investments, an asset management company specializing in digital currencies.

Wherever the threshold lies, it’s clear we’ve passed it. Here’s why:

  • The drop in value was steep: The total value, or market cap, of the largest 100 cryptocurrencies on July 24, 2022, was $1 trillion. That’s a 62% fall from a market cap of $2.7 trillion on November 7, 2021.

  • The downturn was widespread and is ongoing: As of July 24, 2022, all 100 of the largest 100 cryptocurrencies are worth less than they were nine months previously.

This crypto winter is different than the previous one

The last crypto winter occurred in 2018, when the price of Bitcoin dropped by more than 50% from its all-time high in the middle of a bull market in traditional finance.

The difference between then and now? “This is the first time we’re actually seeing crypto trading lower [than before] in a traditional bear market,” says Joel Kruger, a market strategist at LMAX Group, which specializes in cryptocurrency services for institutional investors. The bear market could make a crypto recovery more challenging.

“As [crypto] has gotten larger, there’s been more sensitivity to the intersection with the traditional finance market and fundamentals,” Kruger says.

The current downturn in crypto prices is part of a global sell-off of nearly all asset classes, rather than something specific to crypto. However, there are a few instances of crypto-specific issues, such as the collapse of the algorithmic stablecoin TerraUSD (known by the ticker UST) and its sister coin that backed it, called Terra (known by the ticker LUNA). Because Terra sounds so similar to TerraUSD, we’ll refer to Terra as LUNA in the story. (Note: TerraUSD and LUNA have since been rebranded as TerraClassicUSD and Terra Classic, respectively. Thankfully, these new-but-similar names don't come up in this story.)

The collapse of TerraUSD and LUNA

The collapse of TerraUSD and LUNA resulted in $40 billion in investor losses and has had domino effects throughout the crypto industry.

The two coins are linked: TerraUSD is a so-called algorithmic stablecoin that promised stability with a reliable price of $1. And LUNA, its companion coin, was expected to act like a more traditional cryptocurrency with the potential for big price increases.

An algorithmic stablecoin fuses economics and technology to purportedly provide stability to an asset class otherwise known for high volatility. In theory, LUNA’s 1:1 convertibility with TerraUSD, along with TerraUSD’s redemption value pegged at $1, meant that TerraUSD’s price would remain steady. It would be a safe haven for crypto investors much like cash is a safe haven for traditional investors.

In May, this project unraveled. LUNA was worth $116 in April. Since May, the price has hovered around $0.0001. In a July speech at the Bank of England Conference, Federal Reserve Vice Chair Lael Brainard compared it to a classic bank run. The quick demise of LUNA shook individual investors as well as companies with business models that relied on this project to deliver on its promise.

Frozen customer accounts and sudden bankruptcies

While the tech underlying crypto is new, the financial dilemma some crypto companies have recently faced is timeless: If you borrow large amounts of money to make investment bets that don’t pan out, you’re going to have trouble repaying that original loan.

“Specifically, where we saw the failures were in organizations that focused on centralized lending,” Sharif-Askary says. “So, like in any market, you had leverage exacerbating market swings.” Or, as Warren Buffet famously wrote, “You only find out who is swimming naked when the tide goes out.”

The stories below highlight how quickly the fortunes changed for companies that, only months before, were seemingly swimming in success.

  • Celsius Network opened in 2017 and operated much like a bank. Users could deposit crypto and earn interest — up to 17%, according to the company’s website — and Celsius would issue loans against those deposits. (Last year, regulators in multiple states questioned the legality of Celsius products.) In June 2022, the company barred its 1.7 million users from withdrawing or transferring funds — valued at $20 billion at its peak. In July, the company filed for bankruptcy. In a court filing, the company stated that its assets had plummeted by 80% between March 30 and July 14, 2022.

  • Three Arrows Capital, a crypto hedge fund, managed about $10 billion in assets at its peak before crypto price declines left the company unable to repay loans worth billions. Its founders went into hiding after filing for bankruptcy and their whereabouts are still unknown.

  • Voyager Digital, a crypto brokerage service, filed for bankruptcy in July. Prior to this filing, it paused customer withdrawals. The company cited Three Arrows Capital’s failure to make a $350 million loan payment as a primary reason for its financial troubles.

Kruger says the problems facing these companies “are management issues, not representative of the asset class. These are people that are trying to take advantage of a market that’s doing well and are overexposed.”

But these events do bring into relief the fact that some consumer safeguards found in traditional financial products — such as FDIC insurance, which protects savers in the event their bank goes under — are absent in crypto.

What does the future hold?

One popular maxim states that drawdowns happen about every four years. For some, that regularity is cause for optimism.

“I think a lot of investors we’re talking to see this as an opportunity,” Sharif-Askary says. “It’s a reminder that leverage in a system can exacerbate losses. It reinforces the importance of diversification.”

The shock of the initial price drops might have worn off, but winter has not yet thawed into spring. Sharif-Askary points to a Grayscale white paper released in July that states Bitcoin, a proxy for the crypto market, could “see another five to six months of downward or sideways price movement.”

In the meantime, news about some firms freezing customer accounts is a good reminder to do your due diligence when selecting companies to work with, says Kruger, rather than a reason to write off the sector altogether. If you see promises of extremely high yields, he says, “An alarm bell should be going off in your gut.”

Disclosure: The author and editor held no positions in the aforementioned investments at the original time of publication.

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