Why Is Crypto Crashing?

Cryptocurrencies’ market capitalization fell by $1 trillion from January to May 2022.

The cryptocurrency industry had grown to a point where its market capitalization was in the trillions. However, the industry has been in free fall in 2022, with most cryptos losing more than half of their value. As a result, crypto lenders are losing their money, and algorithmic stable coins are collapsing.

Today, the crypto industry is in a bear market. Why is crypto crashing?

Some people believe the general global recession and inflation could impact the cryptocurrency market. Others are pointing fingers at the cryptocurrency bubble.

So what is happening? Here is what experts think could be the problem.

Recession Looms

The cryptocurrency market is dependent on the traditional global market. Recessions in the traditional global market have serious consequences for all major cryptocurrencies.

There have been fears of a global recession since late 2021. In June 2022, Deutsche Bank predicted a 50% chance of a global recession before the end of 2022.

The fears of a global recession are causing panic in the crypto-currency market. Institutions, individuals, and investors have started to panic about cryptocurrency selling.

These panic withdrawals have increased the volatility of an already volatile market. The result is a sharp drop in the price of major cryptocurrencies, especially Bitcoin.

Another major impact of the recession is that people become more reluctant to invest. Instead, the focus is on holding on to money and waiting for the economy to improve.

When people are afraid to invest, there is no capital circulating in the crypto market. Consequently, crypto sellers are unable to find buyers within a short time. This creates a mismatch between supply and demand.

The overall effect of fears of recession is an increase in supply and a fall in demand. Inevitably, the falling demand will see crypto crashing.

Inflation Is Soaring

Many investors often consider cryptocurrencies to be the best inflation hedge. Nevertheless, the purchasing power of the US dollar has been increasing greatly against cryptocurrencies throughout 2022. Many observers have pointed fingers at a combination of socio-political factors.

Inflation occurs when the price of services and goods suddenly rises across all industries. Many economists have long claimed that cryptocurrencies can’t suffer inflation as fiat currencies. But as inflation continues to rise, the Bitcoin market also seems to be affected.

This is because Bitcoin has become a major part of the global economy. It now directly correlates with the main market indices: the NASDAQ and S&P 500.

Similarly, the use of Bitcoin as a fiat currency has increased greatly over the last few years. Therefore, when the price of goods rises, the value of bitcoin is likely to fall.

Interest Rates Are Rising

As inflation rises, the Federal Reserve reacts by raising interest rates to reverse the trend. So far, the federal funds rate has reached 3.5% and will cross the 4% mark in 2023.

These rising rates may be good news for lenders, but borrowers will be on the receiving end. Many will be forced to liquidate high-risk assets and transfer their investments to safer assets. Speculative assets such as cryptocurrencies and stocks will suffer when interest rates increase.

Rising interest rates increase the competition for capital as people have little money to invest. Investors will also be reluctant to invest in high-risk assets when interest rates are going up. This hurts cryptocurrencies.

Many investors will now do a risk-reward analysis before investing. They will likely go for stable investments, such as bonds, with relatively lower returns. As bond prices start to rise, investors will dispose of the higher-risk assets such as Bitcoin.

The transition to low-risk assets has a cascading effect on the crypto market. The speculation on bonds and other guaranteed assets will attract capital from the stock and crypto market. The overall effect is insufficient or low capital circulating in the cryptocurrency market.

Living Costs Are Biting

2022 has been one of the worst years for most people. The majority of people are struggling to make ends meet and pay bills.

Household rents have increased across the United States. In addition, the price of food has also been on the rise since February 2022.

Perhaps the biggest effect on the cost of living has been the rise in fuel prices. With people having to spend more money at the pump, there’s little left for other things.

The rising cost of living means people spend more of their income on basic needs. In that light, the money invested in cryptocurrencies will be low.

Stock Markets Are Wobbling

Investors have long preferred to invest in the equity market and avoid the volatility of cryptocurrencies. However, the increasing market capitalization of cryptocurrencies has linked the crypto and stock market.

Today, many factors that influence the stock markets also impact the crypto market. Moreover, investors put stocks and crypto in the same category. Consequently, changes in the stock market will trickle down to the cryptocurrency industry.

Before the pandemic, major cryptocurrencies had entered the mainstream financial system. Investors considered them a viable diversification option. This became even more pronounced when the prices of Bitcoin kept rising steadily.

There has been a dramatic drop in the stock market throughout 2022. Part of this has been due to the uncertainty brought about by Russia’s invasion of Ukraine. Another contributing factor to the stock market roller coaster is a lack of confidence in the economy.

While the stock market has not completely crashed, it has slowed down throughout the year. All the major indices, such as S&P, are down by double digits. Similarly, the Dow Jones average got losses for seven consecutive weeks.

The problems in the stock market are causing a crypto drop. This is because people fear that speculative asset prices will keep falling.

Lack of Intrinsic Value

An intrinsic value refers to the value that a commodity possesses in itself. This means that fiat currencies are valuable because tangible assets underpin them.

On the other hand, all cryptocurrencies have no intrinsic value. Their value is speculative and depends on the agreements between buyers and sellers.

While stocks are based on a company’s ability to sell goods and services, a cryptocurrency is not backed up by anything. This makes it a purely speculative asset and a minor currency.

The value of Bitcoin depends entirely on market confidence. If millions of people believe that its price will rise, investors will buy and hold the asset. You can read here to learn how bitcoin became so popular.

The belief that bitcoin would keep rising was behind its astronomical growth throughout the 2010s.The problem with a speculative asset is that it’s based on beliefs. If many people suspect that a crypto crash is imminent, investors will start to sell.

That is what happened in the middle of 2022. A slight drop in the price of Bitcoin created industry-wide panic. Bitcoin had lost more than a third of its value within a few days.

Crypto Exchanges Paused Withdrawals

Inflation and rising interest rates have caused great uncertainty amongst investors. Many of these investors have decided to sell off their assets and reduce their liquidity.

Massive sell-offs are a strain on an already struggling cryptocurrency market. This is in addition to the fact that many investors are completely leaving the crypto industry.

Crypto exchange companies found themselves in the middle of these liquidations. Many exchanges decided to pause withdrawals:

Binance stopped bitcoin withdrawals as of June 2022
Celsius Network halted all transfers and withdrawals, citing an unfavorable market environment
CoinFLEX froze user withdrawals on June 23rd, 2022
Finblox placed a withdrawal limit to prevent extreme market exposure
Voyager Digital reduced daily withdrawal limit

Crypto exchanges took these actions because they don’t have stable reserves of liquid cash. Their cash reserves are a small percentage of the speculative value of the crypto in the wallets of their investors.

This makes it difficult for cryptocurrencies to pay out every investor. Unfortunately, such a situation reduces confidence in the cryptocurrency industry. For example, people will be afraid to put their money in an industry where they may be stopped from withdrawing it.

The current situation is that there is a limit on the number of withdrawals and transfers between some crypto exchange platforms. Therefore, investors will try to sell their digital assets as quickly as possible.

Regulatory Action

Over the years, the government has developed clear regulations to control the stock market. Stock investors now know what to expect and what is illegal when trading stocks.

Unfortunately, very few regulations exist to manage the cryptocurrency industry. Some jurisdictions don’t even recognize the cryptocurrency industry as a legitimate market.

Is this why the crypto market industry is collapsing?

Predictability and clarity are a key part of any stable market. If individual players have the freedom to set up their own regulations, then there will be confusion. That is probably why the government is trying to create laws for the crypto industry.

Lack of regulation isn’t an entirely bad thing. The lack of controls and measures can speed up transactions and create high market flexibility. This is precisely why early investors in Bitcoin made a killing.

Cryptocurrencies are not regarded as legal tender by the federal and state governments in the US. However, a cryptocurrency exchange is legal and subscribes to regulations at the state level.

The Financial Crimes Enforcement Network has classified cryptos as money transmitters. The same position has long been held by the internal revenue authority.

The biggest regulation development is the application of the Bank Secrecy Act to the cryptocurrency industry. This act redefines the anonymous and decentralized nature of cryptocurrencies.

Cryptocurrency exchanges now have to register with the government and keep appropriate records. The exchanges must also require proof of identity from people with digital wallets on their platforms.

The government also requires crypto exchange platforms to provide reports of activities on their sites regularly. The result is that the flexibility of Bitcoin transactions is going down. And as the fears of further government regulation continue spreading, investors will be reluctant to invest in cryptocurrency.

China’s Recent Crackdown on Crypto Services

China’s Central Bank declared all forms of cryptocurrencies illegal in September 2021. The Central Bank cited illegal financial transactions as the motive behind the ban.

Prior to this action, China was home to the largest cryptocurrency market in the world. The sudden removal of such a huge market sent cryptocurrency prices tumbling down.

The Central Bank of China stopped payment platforms and banks from processing transactions related to cryptocurrencies. It also made it illegal to mine new coins in China.

The ban on mining had a major impact on Bitcoin transactions in the world. China was the Bitcoin mining center due to its low electricity costs and cheap computing infrastructure.

China’s crackdown also caused fears around the world, particularly in Asia. Many investors were afraid that the US government would also follow in China’s footsteps and ban cryptocurrency in the US.

Negative Remarks From Elon Musk

One of the biggest indications of cryptocurrency’s volatility is its reliance on influencer endorsement. This became apparent when a single tweet from Elon musk caused a panic in the Bitcoin market.

In early June 2022, Elon Musk tweeted his concerns about Bitcoin. Within a matter of hours, Bitcoin’s value dropped. Although the tweet was about Bitcoin, it created a panic in the entire cryptocurrency industry.