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The world of cryptocurrencies is in chaos.
Just a few months ago, crypto companies were hyping heavily during the Super Bowl after virtual currencies enjoyed a dizzying rally in 2021.
Today, Bitcoin and other cryptocurrencies are crashing, and companies like Coinbase, which runs the largest cryptocurrency exchange in the US, are announcing layoffs.
“The crypto house is on fire and everyone is rushing out because there is a complete loss of confidence in the space,” says Ed Moya, senior markets strategist at financial firm Oanda.
This is what is happening.
Why are cryptos falling so sharply?
Because they are affected by the same factors that affect stocks and other assets.
Consumer prices are rising at the fastest annual pace in more than four decades, and the Federal Reserve is aggressively raising interest rates to reduce inflation.
On Thursday, the Fed raised rates by three-quarters of a percentage point and indicated it could raise them again by the same amount at its next meeting in July if needed to cool prices.
Higher interest rates make borrowing costs more expensive for individuals and businesses, raising concerns about an economic downturn.
Stocks have fallen sharply from records set in January, with the broad S&P 500 index entering a bear market this week (when an index falls 20% or more from its recent high).
Cryptocurrencies have hardly been immune. Since Bitcoin hit an all-time high in November, the value of the world’s most popular digital currency has fallen by around 70%, and its rivals are suffering too. Ether is down around 70% this year, as is Dogecoin.
Bitcoin backers have always claimed that the digital currency would be an “inflation hedge,” but in fact, it hasn’t behaved that way.
As tech company stocks have plummeted, so has the value of Bitcoin.
“What this episode, this drop in cryptocurrency prices, shows is that cryptocurrencies are, by and large, speculative financial assets that are subject to macroeconomic forces, such as changes in interest rates,” says Eswar Prasad, professor of economics at Cornell University.
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So what does this mean for crypto companies?
The sharp declines in cryptocurrencies are leading some companies into trouble.
Celsius, which takes cryptocurrency deposits from individuals and lends them out, has halted withdrawals because it is facing financial problems. Binance, a cryptocurrency exchange, halted Bitcoin withdrawals for several hours on Monday.
The problems in Celsius are undermining confidence in the broader cryptocurrency space just weeks after the collapse of a stablecoin called TerraUSD.
Crypto companies are responding by reevaluating their plans for the future.
Coinbase, a cryptocurrency exchange platform, has cut its staff by almost a fifth.
In a memo to staff, the company’s CEO said Coinbase “grew too fast.”
“It looks like we are entering a recession,” wrote Brian Armstrong.
Some cryptocurrency supporters still believe that a “crypto winter” could lead to a “crypto spring.” In the past, deep recessions have led to strong rallies.
But according to Moya, an analyst at Oanda, the economic landscape is different now, as is the outlook for cryptocurrencies.
In fact, with the Federal Reserve continuing to aggressively raise interest rates and inflation remaining high, there is likely to be more pain ahead in all markets, including cryptocurrencies.
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What dosage does this mean for those who got into crypto?
It has been a rude awakening for the millions of people who bought cryptocurrencies, especially if they caught on last year.
Prasad says that 2021 was “the height of cryptomania.”
The total value of all digital currencies in the world increased to $3 trillion. Crypto companies signed endorsement deals with professional sports teams, and Coinbase, Crypto.com, eToro, and FTX shelled out millions of dollars to buy ads during the Super Bowl.
Crypto.com hired actor Matt Damon as a spokesperson, and an FTX ad featured curmudgeonly comedian Larry David.
The message from these companies was that cryptocurrencies represent the future of finance and that it was better not to miss out.
“The technological daze of cryptocurrencies swept away many retail investors who didn’t realize the kind of risks they were taking,” says Prasad.
Today, the total value of the crypto market has dropped to around $1 trillion. And if you bought Bitcoin on February 14, the day after the Super Bowl ad bonanza, it is now worth about half of what you paid for it.
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What will this mean for the regulation of the sector?
The rise of amateur investors, combined with the increasing complexity of some of the cryptocurrency products, has regulators worried.
Crypto markets are still fairly new and there is a lack of clarity about even the most basic things, like who is in charge of overseeing the space.
Right now, both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) claim that they oversee parts of the crypto market.
“If there’s no guidance, people will be taken advantage of, and we want to avoid that,” says Cam Harvey, a finance professor at Duke University. “Right now, we basically have nothing.”
The SEC is stepping up enforcement actions against crypto companies and considering new rules. Meanwhile, in an executive order, President Biden asked government agencies to make policy recommendations.
And in Congress, Sen. Cynthia Lummis (R-WY) has partnered with Sen. Kirsten Gillibrand (D-NY) on the first comprehensive crypto legislation. The bill would give more regulatory authority to the Commodity Futures Trading Commission.
Still, for now, many analysts don’t think the broader financial system is at risk. The total market value of cryptocurrencies is still less than the total market value of a large company like Apple.
But this recent recession has raised some serious concerns.