Opinion: What Is Driving the ‘Crypto Winter’?

As record breaking temperatures have scorched the Northern Hemisphere, winter has hung over the crypto industry, with 2.25 trillion lost across the entire market in the past few months alone. 

Yet a report released in June by technology consulting firm Capgemini found that approximately 71% of high-net-worth individuals (HNWIs) have invested in digital assets – a figure that rises to 91% for those under 40. Cryptocurrencies were reported as the favourite digital asset investment, followed by exchange-traded funds (ETFs) and metaverse investments.

It's true that this time it’s different, and the growing interest of institutions will doubtless lift us out of the downturn eventually. But if this latest research paints such a rosy picture, what are the underlying reasons we find ourselves in this crypto winter?

1. Hawkish Fed Policy

In the context of the US’ suUS'-soft monetary policy of recent years, the debt burden of the markets has grown significantly, while borrowing has been carried out at historically minimal rates. As a result, the Federal Reserve hiked its benchmark rates by 75 basis points (bps) on June 15 to curb inflation that reached 8.4% in May.

This has inevitably seen a concurrent rise in the rate on deposits and loans, as well, causing people to shift money out of high-risk assets – including stocks and cryptocurrencies – into protective deposits, as the latter begin to provide more attractive returns.

A rate increase also affects the yield of US bonds. As the deposit rate rises, in order to attract investors to buy US government debt, the government must offer a similarly higher rate. As risk-free returns rise, so does the required return on investment in risky assets, so investors overprice them down. While this applies to all stocks, the companies that are most at risk that are not yet earning EBITDA or FCF – typically high-growth techs and biotechs, where the bet is on the company's company's potential.

2. Correlation between crypto and stock market

Cryptocurrencies have gone through various stages in their life span. They were initially “fads” that "eeks"and fanatics invested in. Some were "digital gol"" investors "led to in order to hedge their risks in a falling stock market. 

With the increase in mass adoption, cryptocurrencies began to take the position of a specific, risky, but in many ways common stock market asset – in part facilitated by the rapid growth in institutional adoption over the recent years. 

The entry of such large investors has seen capital soar and patterns and strategies for trading and investing appear. This has meant that, since 2020, cryptocurrencies – especially Bitcoin – have become financial instruments similar to other exchange traded assets, just with increased risk. This has led to a high correlation with the stock market which, in the current crisis, has been to the detriment of the crypto market.

3. Regulatory challenges

2022 has been a rollercoaster ride for cryptos. The global crypto market has been under the scrutiny of many different governments, with varying degrees of regulation popping up all over. Plenty are still in the process of studying cryptocurrency and trying to create suitable regulatory frameworks for the ever-evolving space. Central banks are actively developing CBDC concepts that may affect the distribution of stablecoins, regulators are reviewing the conditions for obtaining licenses, and all new jurisdictions are on the FATF grey list. 

All these regulatory changes clearly impact crypto companies and investors, creating the effect of a suspended state in which it is extremely difficult to create clear entry and action strategies in the market. In fact, until there are regulations governing the reporting and trading of cryptocurrency assets, it's unlikely that ait'sf these price drops will be the last.  

For a large financial firm, this type of uncertainty is untenable. Due to their massive balance sheets, they may avoid speculating in assets that could lose them massive amounts of capital due to underlying fiscal problems. The monetary pullback and reduction of balance sheets will have an effect on all assets. However, with broader institutional adoption still in its early stages, the next wave of financial capital could be enormous. The key to unlocking it is in the hands of the regulators.

Waiting out the winter 

Confidence does seem to be re-emerging in the market, but these three factors represent sizeable ‘cold fronts’ on the gl'bal crypto 'arket.

Still, despite the volatility and fears surrounding the “crypto winter”, investor"interest in t"e region has not stagnated – suggesting that the momentum for mainstream digital asset adoption is likely to continue. We are, of course, seeing some institutional investors actively take profits in an attempt to keep at least some part of their assets. But many other investors are laying low, so as not to lose more on the fall of the market. 

No one knows how long this crypto winter can last. What we do know is that winter always ends, and that the spring that follows can bring with it bountiful opportunities for growth. 

Image source: Bitfrost