After a Fall, Crypto Winter Sets In

Cryptocurrencies hit a rough patch in 2022, with prices falling, Luna and Terra crashing and FTX filing for bankruptcy.

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In the first half of 2022, the price of every major cryptocurrency dropped following the collapse of TerraUSD and LUNA. Now, multiple crypto-related companies are facing serious financial difficulties, including insolvency. In November 2022, crypto exchanges FTX and FTX.US filed for Chapter 11 bankruptcy. BlockFi, another exchange, which filed for Chapter 11 bankruptcy on Nov 28. The fallout of this crypto crash is ongoing. 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 Nov. 14, 2022, was about $830 billion. That’s about a 70% fall from a market cap of $2.7 trillion on Nov. 7, 2021.

  • The downturn was widespread and is ongoing: As of Nov. 14, 2022, the prices on the vast majority of the largest 100 cryptocurrencies by market cap have dropped by double-digits year-to-date.

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 collapse of TerraUSD and LUNA

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) resulted in $40 billion in investor losses and has had domino effects throughout the crypto industry. 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.)

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 dropped to a small fraction of a penny. 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. Or, as famed investor Warren Buffett once wrote, "it's only when the tide goes out that you learn who's been swimming naked."

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.

  • FTX and FTX.US, both major crypto exchanges, filed for bankruptcy on Nov. 11, 2022. The move happened after a sell-off of FTX's native token, FTT, and a large volume of withdrawals. Shortly after filing for bankruptcy, the exchanges were hit by an apparent hack, which drained hundreds of millions of dollars from user wallets.

  • BlockFi, a crypto exchange, froze customer withdrawals and stopped normal business operations following the FTX crash. On Nov. 28, it filed for bankruptcy. Previously, it had a line of credit with FTX.US and was set to be acquired by the company.

These events show that, despite the widespread adoption of crypto in the past decade, it's still the Wild West. Crypto exchanges lack some consumer safeguards found in traditional financial products — such as FDIC insurance, which protects savers in the event their bank goes under. And some exchanges take big risks with user assets that can result in losses.

🤓Nerdy Tip

If you're worried about keeping your crypto with an exchange, consider moving your digital assets to a separate crypto wallet. Most exchanges allow you to transfer assets to these wallets, which can be online (on a separate platform) or offline (on a thumb drive with added security features).

What does the future hold?

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

But keep in mind that a recovery could take months or years, and the market could get worse before it gets better. More crypto companies exposed directly or indirectly to the fallout from crypto winter could collapse. Various cryptocurrencies could go to zero, or close to zero, following massive sell-offs.

As a rule of thumb, only invest what you can afford to lose in risky assets like crypto. While some prices may recover, many might not.

» What's next: Will Bitcoin go back up?

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

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