Dubbed the Crypto Winter, the cryptocurrency market has gone through a tough period with companies collapsing, major fines and token prices dropping. However, players in the industry are confident spring is coming.
One of the biggest shocks to the cryptocurrency market was the collapse of trading giant FTX. The firm filed for bankruptcy in November, despite having been valued at $32bn in February. The company’s founder Sam Bankman-Fried is currently on trial for claims he defrauded customers.
Another recent challenge to face the cryptocurrency market was crypto broker Genesis’ filing for bankruptcy protection. The filing came shortly after it was revealed the firm owed over $3bn to creditors and its parent company Digital Currency Group was looking to sell assets in its portfolio to support the company.
Other companies to feel the effect of the crypto winter are Three Arrows Capital, Terra Network, Voyager Digital, BlockFi and many others. Then there is the collapse of stablecoins Luna and TerraUSD earlier in 2022.
Sankar Krishnan – executive vice president, head digital assets & FinTech at Capgemini Financial Services – said, “Despite the Crypto meltdown the crypto market is set to surpass $6trn by 2025. Other than bitcoin and Ethereum we are seeing traction in other currencies such as Ripple (XRP), Polygon(MATIC), Polkadot (DOT, Solana (SOL) and others. Some of these coins may also have a role as a transacting currency in the Metaverse as and when it develops as a transaction exchange.
“FTX was the 11th in a series of 2022 shakeouts and it is likely that there will be more of similar bankruptcies going forward. That said it is important to note that the bankruptcies are largely a function of bad management, greed, and fraud and decentralised technology was never the problem.”
A common consensus from the crypto market is that this is not the end of cryptocurrency, but rather a wave of needed consolidation. Martin Masser, senior product manager of crypto at Lab49, said, “Digital assets themselves were not the root cause of FTX and Genesis’ bankruptcy filings, the issue was both platforms making bad business decisions. Many platforms have taken risks with their user’s assets, such as those not storing funds 1:1 as many thought and instead lending them out as collateralised loans.”
In a similar vein, Alan Vey – founder and CEO of enterprise blockchain Aventus – said, “The current ‘crypto winter’ is a necessary step for the inevitable market consolidation, weeding out weaker projects who are too reliant on poor fundamentals and inflated media hype. That said, the recent increase in the value of Ethereum and Bitcoin suggests the market will re-stabilise and this could yet be a good for investing in crypto. There is, however, a long way to go to restore investors’ trust, and that begins with robust regulation.”
While there have been various media reports about the Crypto Winter, it seems that users are not as worried as the bankruptcies and price drops suggest. Amplitude, a digital analytics platform, recently found that overall crypto usage has grown by 25.8% since 2021. The finding came from its new Amplitude’s 2022 Product Report, which also found activity peaked at 78% growth in January 2022. It added that the growth levels are higher than FinTech and that a dip in the market doesn’t equal a decline in users.
It is also worth noting that these Crypto Winters have happened many times in the lifecycle of cryptocurrency, each hailing the end of the digital currency, but that has not happened. A keen example of this is the dip of bitcoin prices in 2017 when its price dropped by 45% from its peak. The currency soon went to new heights. In 2022, bitcoin lost 60% of its value. However, the currency is on the rise again with its price rising from $16,000 at the start of January to $24,000 (at the time of writing).
There are many factors that cause the fluctuating price of cryptocurrencies. Lack of regulation, high profility of bad actors, slow transactions, high-energy consumption, oversaturated market and more. Capgemini’s Krishnan said, “As crypto is still away from full maturity, there will be several such periods of highs and lows that crypto will go through. The current movement in crypto is only a learning curve, and it will be crucial for regulators and enterprises to work in sync to convert this opportunity.”
Lennix Lai, director of financial markets at crypto exchange OKX, said, “It’s harrowing that retail investors will inevitably bear the cost of excessive risks taken by certain institutions. Yet, we need to let companies with unsustainable crypto operations get shaken out of the market.
“The domino effect we’re seeing among crypto firms is akin to the 2008 financial crash among Wall Street firms. Both cases resulted from institutions taking illogical risk, largely at the expense of retail investors. The irony is that the behaviour that’s been exhibited by troubled crypto firms is exactly the type of activity that crypto is supposed to relieve us from: withdrawal freezes, alarming opacity, general mismanagement of customer funds, and so on.”
Broken Trust
A major knock-on effect of the collapse of FTX and Genesis has been on the trust of consumers. However, many firms are trying to restore this faith. In the wake of the FTX collapse, Binance CEO Changpeng Zhao emailed retail investors to reassure them that everything the firm does is above board. As part of this, he outlined that clients’ assets are stored in segregated accounts and are not used by the company.
Lars Holst, founder and CEO of digital brokerage GCEX, said, “Of course there has been an impact from FTX and Genesis. Whenever there are crooks and bad practices involved in a situation, faith in the sector drops – and rightly so! However, in terms of the digital asset industry, I see this as having a short-term impact. It’s up to the credible and experienced institutional players in the market to rebuild that faith and to educate investors about the importance of doing their due diligence and to only dealing with regulated entities who don’t self-custody.”
While faith in cryptocurrency companies has taken a hit, investors are still backing cryptocurrency-focused companies at a range of growth-stages. For example, crypto trading platform Amber raised $300m in late 2022, bitcoin infrastructure firm Blockstream recently raised $125m and Centbee raised $1m in funding to support cryptocurrency remittances. There is still a steady stream of crypto-focused businesses raising capital despite the Crypto Winter and a financial market where raising funds is tough.
However, damage has been done to the market and some will likely be cautious about getting involved with cryptocurrency or resuming their activity.
Milosz Papst, director at leading investment research firm Edison Group, said, “I think it is critical to improve the transparency and risk management policies of centralised crypto actors such as exchanges and lending platforms, so that investors are re-assured that their assets are safe and that the balance sheets of these entities are prudently managed. For instance, real-time (or at least frequent) attestations of assets and liabilities should become more common. Progress in well-designed crypto regulations should also help inspire investor confidence in the industry.”
Lab49’s Masser stated that restoring faith in cryptocurrency is a multi-step process. Fundamental to this is building regulation and reducing bad actors. One of the best ways to restore trust, Masser believes, is through improved self-custody. He added, “The phrase, “not your keys, not your crypto” refers to the fact that a user should have control over their own assets, as opposed to an exchange platform. It was raised after the Mt. Gox collapse in 2014 and is still as relevant today as it was then.”
While there is a lack of faith in the market, consumers will still invest into cryptocurrency. GCEX’s Holst said, “They will certainly be more selective and will look for more substance and less hype. Investors need to do their homework thoroughly before jumping in too fast. They need to ask questions such as: What does the token do? Does it make sense for me to invest in it? Who is behind it? What is the track record in the financial services sector of the people behind the token? What gives them credibility in this space?
“Investors should also think carefully about who they trade with and only deal with regulated entities. They should also do due diligence and look at the track records of the people who are running these firms and always check that they are dealing with credible firms and not shell companies.”
However, there will be winners and losers. Professor Alexander Brauneis from the new Centre for Finance, Technology and Society at Nottingham Business School said, “Many of the 10,000+ tokens listed on coingecko and coinmarketcap will likely not survive the current market conditions. However, blockchain data for bigger crypto currencies show an increasing number of daily active users, number of addresses with a certain balance and number of daily transactions.”
Rising regulation
While the regulation around cryptocurrency has been slowly trickling in over the years, pressure is rising to implement more protections.
Four senior US officials in the White House recently called on the US Congress to ‘step up its efforts’ in regulating the cryptocurrency market. Similarly, federal bank regulatory agencies issued a joint statement to highlight key risks for banking organisations involved with cryptos.
Across the pond, the UK government recently unveiled proposals to put cryptoassets into the same regulatory regime as traditional financial services. Five associations in the UK also formed an alliance to help guid the UK’s digital currency future through policy, practice and regulation.
As for the EU, it is preparing to launch the Markets in Crypto-Assets (MiCA) Regulation, which would introduce a new framework for European crypto-assets. Its aim is to bolster protection for investors and ensure financial stability whilst maintaining the innovation of the asset type.
Implementing regulation that boosts protection but not at the expense of innovation is something Aventus’ Vey is eager for. He said, “Crypto was created to transcend traditional regulatory frameworks, meaning its volatile nature makes it the black sheep of the finance sphere. Calls to increase regulation is a need to be met ensuring the safety of users, but this must be imposed without stifling progress.”
“Regulators must capitalise on the gradually improving attitudes towards the major coins to reinvigorate the power of the wider industry and incentivise institutional investors to engage with cryptocurrencies. Even at Ethereum’s lowest point, in recent memory it’s been difficult to imagine a future without it.”
Also commenting on the need for a stricter regulatory framework, Olivier Fines – head of advocacy and policy research, EMEA at not-for-profit financial education organisation CFA Institute – said, “A strong regulatory framework needs to be established for the benefit of both crypto providers and users. Policymakers must either agree on the application of existing laws to various components in the crypto ecosystem or craft new laws to fill in any gaps. Trust in the integrity of crypto markets is essential to attract investors and build crypto networks to scale.
“Crypto platforms combine many of the functions that in mainstream finance are kept separate, such as the roles of brokerages, exchanges, market makers, custodians, and clearing agencies. Existing regulations that intend to prevent traditional finance firms from using customers’ assets to fund their own or affiliated businesses may not always provide similar protections for investors in crypto. The debacle at FTX shows the harm that can come to investors and platform participants when client assets are not kept safe. The example of FTX further underlines the importance of custody issues and the responsibility of investors to base their decisions on the investment case and not on hype and speculation.”
Professor Nafis Alam – head of school of business at Monash University Malaysia – is confident 2023 will be a good year for cryptocurrency regulation. Alam said, “If 2022 were the year of failed legislative approaches for the crypto industry, 2023 would be the year of regulation. Regulation is essential to retaining crypto’s popularity and building back the lost trust among crypto enthusiasts.”
Despite the caution towards cryptocurrencies over the years, many governments around the world are working on their own Central Bank Digital Currency (CBDC). Earlier this week, the Bank of Japan moved into the proof-of-concept pilot stage for its CBDC to test feasibility of core functions and features. Similarly, the Central Bank of the Republic of Turkey (CBRT) recently concluded the first test transactions for its digital Turkish Lira CBDC network.
Other countries to have held tests include France, Luxembourg, Singapore, Israel, the UK, Sweden and Norway. Late last year, the Federal Reserve Bank of New York and the Monetary Authority of Singapore (MAS) have linked to explore the use of wholesale CBDCs for cross-border payments.
While most focus is placed on cryptocurrency, 2023 could be a big year for CBDC around the world.
Is 2023 the death of crypto?
While the future is impossible to predict, if the response from industry players is anything to go by, this is not the end of cryptocurrency.
Skybridge Capital founder recently exclaimed that the time to invest into cryptocurrency is now. This is simply because the market is nearer the bottom than the top.
Lab 49’s Masser agreed that this is a good time to invest. He said, “Considering the second biggest exchange imploded in under a week, prices did not nosedive to the extent that would have been expected. What’s perhaps most interesting at the moment is how we’re witnessing an increasing number of nations wanting to become ‘crypto hubs’. Traditional financial institutions wish to expand with a crypto focus.”
Capgemini’s Krishnan echoed this. He said, “Mr. Scaramucci has always been calling out the volatility in crypto and has always said that not more than 5% of investment in crypto. Given that prices of bitcoin and Ethereum are at an all time low it is not a bad time to look at crypto and see how they may have a role in your asset allocation model. Needless to say, safety first.” Instead of being the death of the asset type, Krishnan believes it is the opposite. “2023 is a step towards making crypto investor friendly.”
Louise Abbott, cryptocurrency fraud partner at Keystone Law concluded, “The Crypto winter will thaw to a spring awakening! Crypto is here is stay, and digital assets are the future.”
Copyright © 2018 RegTech Analyst
