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Saturday, January 28, 2023

2022’s Top Crypto Events, and the 2023 Crypto Outlook: Drama, Contagion and Hope

 

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2022 was a year of unprecedented events for the cryptocurrency ecosystem. As a year that will be remembered as a difficult year in crypto history comes to an end, let’s take a look back at the most important events of the year and evaluate what awaits the crypto industry in 2023.

Q1 2022: Crypto markets get hit by the economy’s shift

Cryptocurrencies’ bull market lasted from the second quarter of 2020 until the last months of 2021. This was a period marked by the global struggle against the COVID-19 pandemic. Countries around the world opened the money spigots to mitigate the negative economic effects of the pandemic, and there was a significant inflow of funds into global markets. This increased the appetite for risk and the flow of funds from institutional investors into cryptocurrency markets accelerated. At the time of the peak, the cryptocurrency market capitalization had reached $3 trillion and the Bitcoin price hit a record high of $69,000.

Global central banks’ aggressively loose monetary policy throughout the pandemic left the world with a serious inflation problem. So, in the last quarter of 2021, the U.S. Fed signaled the end of that monetary policy and a shift to a tightening monetary policy, with tools such as balance sheet contraction and interest rate hikes at their disposal. And so ended the bull market for cryptocurrencies.

If COVID-19 response-induced inflation was not enough, Russia’s invasion of Ukraine further disrupted supply chains worldwide. This further fueled inflation by negatively affecting production costs.

Crypto markets were not immediately affected by the war, as cryptocurrencies even served as a means of aid to Ukraine via crypto asset transfers. On the flip side, a media narrative developed that Russia could use cryptocurrencies to circumvent sanctions imposed on it by global governments due to the war. These developments would lead to a series of events that profoundly affected all global markets, affecting cryptocurrency markets later on.

The decline that began in November slowed somewhat in Q1, with Bitcoin finding support in the $37,000 band. By the end of March, it saw a bounce that reached as high as $48,000, as the sector reacted positively to the slowdown in inflation growth and the Fed’s initial rate hike of only 25 basis points.

Q2 2022: Cryptocurrency firm bankruptcies pick up

The recovery proved short-lived as the second quarter began, as the slowdown in the global economy began to take its toll on the markets.

Institutional investors started reducing their holdings in risky markets as the Fed’s determination to slow inflation became clear. After lenders withdrew their support from the market, the liquidity problems caught crypto companies off guard. The Terra ecosystem was the first to be affected, triggering a collapse that would drive many companies into bankruptcy.

TerraForm Labs had a significant amount of staking products on its platform, up to 20% for its algorithmic stablecoin UST. As the tide turned and UST sales accelerated, the crypto asset struggled to remain stable. The promise of unsustainable rates of interest return was the catalyst for the series of events that brought the end of the Terra ecosystem. As a result, LUNA, the reserve unit of the UST, was negatively affected by the loss of UST’s stability, and the value of the cryptocurrency plummeted in short order.

The collapse of Terra put the associated lending companies into a liquidity crisis, while also having an extremely negative impact on individual investors, ultimately leading to billions of dollars in losses. In the aftermath, Terra founder Do Kwon fled South Korea and ignored the authorities’ call for his prosecution. Kwon is still at large and wanted by Interpol.

The first major company to be affected was Three Arrows Capital (3AC), a major lender in the crypto ecosystem. Then the financial crisis spread to other major crypto companies including Celsius, Genesis, and other lending companies. As a result, the direct and indirect ties between the companies led to the decline of the entire industry.

By June, Bitcoin’s price had dipped below $30,000. The rise in energy costs around the world and the sharp drop in the price of Bitcoin started to have a negative impact on cryptocurrency miners. Many large mining companies liquidated their BTC holdings to protect their positions, and BTC fell below $20,000 to around $17,000 by the end of the first half of the year.

Q3 2022: Recovery and a focus on the Ethereum Merge

While the Terra collapse plunged the cryptocurrency markets into chaos and made history, cryptocurrencies did eventually see dip buying in the 3rd quarter.

A summer slowdown in U.S. inflation and the pricing in of negative events supported a recovery. From July to mid-August, Bitcoin saw a 30% increase in value, rising from the $19,000 band to $25,000. The recovery stopped there, however, and selling pressure resumed in the second half of August.

Among the events that marked the crypto sector in the summer was the sanction imposed by the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) against Tornado Cash, a transaction scrambling platform operating on the Ethereum network that enables the untraceability of asset transfers. A positive development was Coinbase’s collaboration with the world’s largest asset manager, BlackRock (NYSE:BLK), for crypto asset trading and custody service. In addition, the European Union finalized the crypto asset markets legislation MiCA, which has the potential to guide global crypto regulations. This development, which resonated throughout the market, was seen as an important step in the years-long regulatory debate.

By September, the Ethereum network’s Merge, which had been delayed several times, was finally launched. With the transition from proof-of-work to proof-of-stake consensus mechanism, which has been seen as a turning point for the Ethereum ecosystem, the Ethereum network became an environmentally friendly structure, switching from energy-intensive proof-of-work to a much lighter proof-of-stake process, which is said to save 99.9% of energy used by the network. This addressed the longtime concern about crypto’s environmental impact, but brought another problem with it. This time, critics began to raise the issue of network security and decentralization.

While the Merge caused Ethereum to rise in value in early September amidst the hype, the subsequent action showed traders sold the news. Ethereum mining became a thing of the past and miners began to continue their activities as transaction validators by staking Ether in their portfolios. While Ethereum issuance was expected to decline significantly, Ethereum supply started to become deflationary with the burning mechanism. Post-Merge Blockchain data also revealed that verification processes were in the hands of a small number of accounts, raising concerns about the Ethereum network’s security and centralization. As a result, Ethereum’s price continued to fall along with the rest of the market, failing to see the expected uptick in a market in turmoil post-Merge.

Q4 2022: FTX deals a serious blow to the crypto sector

Entering the last quarter of the year, the crypto market showed signs of new life. Cryptocurrencies managed to close October on a positive note, albeit at a low rate. However, a November storm would drag the entire industry into a new turmoil.

The shock came on November 2 with CoinDesk’s news that Alameda Research, the trading firm associated with FTX, had a problematic balance sheet to say the least. FTX founder Sam Bankman-Fried had taken on the role of savior in the sector through financial support and acquisitions during the Q2 round of problems, and maintained its reputation as a growing company. But Alameda’s leaked balance sheet showed that a significant part of its assets was in FTX Token, an illiquid cryptocoin minted by FTX. The perception that the company was trying to cover its liabilities with illiquid assets caused the market to quickly sour on the rising crypto star.

The first reaction came from FTX’s biggest competitor Binance, with the exchange’s CEO, Changpeng Zhao, announcing that they had learned from Terra and would divest their FTT holdings. This development triggered the acceleration of FTT sales in the market. At the same time, as mass fund exit requests from FTX started to increase, the exchange had to suspend withdrawal requests. As it would later be revealed, Alameda had taken FTX customer funds for their own use for some time.

Following the suspension of withdrawals, FTX and Binance signed a memorandum of understanding for Binance to purchase FTX. Binance then pulled out of the deal during the due diligence process. The back and forth only accelerated FTX’s fall as the brokerage lost its last chance to get out of the crisis. Thus, the world’s second largest crypto exchange was forced to declare bankruptcy in as little as a week. A day after the bankruptcy announcement, FTX continued to make headlines with a suspicious hacking incident.

Throughout the month of November, several cover-ups involving FTX and Alameda Research came to light. It became clear that Alameda had been struggling since May and that FTX had been using client assets to fund Alameda. In December, U.S. authorities announced charges – including defrauding exchange customers, securities fraud, money laundering, and campaign finance fraud – against Bankman-Fried, and he was arrested on December 13 in the Bahamas.

FTX’s rapid collapse caused panic among crypto investors, and crypto asset withdrawals from centralized exchanges have skyrocketed since November. Crypto exchanges began to publish their assets one by one, adopting the proof-of-reserves principle in an effort to regain user trust. However, the sudden termination of cooperation with crypto companies by the auditing firms that determine the reserves of the exchanges has emerged as a new negative.

Amid all this chaos, Bitcoin took another significant hit in the last quarter of the year and reached the lows of 2022 with the rest of the market. With the outbreak of the FTX crisis, Bitcoin fell as low as $15,000 and has been flat at $16,000 since November.

2023 Outlook: Regulation, CBDCs, growth, and struggles

The impact of many negative events throughout the year is likely to continue into the new year. Many market commentators expect the domino effect to continue due to the interconnectedness of crypto companies.

Countries that have so far been slow to regulate crypto may take concrete steps to control the market in 2023, especially as individual investors have also suffered serious losses from 2022’s various incidents. The threat of contagion from the cryptocurrency sector to traditional finance has also increasingly been discussed as a reason to increase regulation. So, 2023 may be referred to as a year of regulation for crypto markets.

On the other hand, there may be important developments in the field of central bank digital currencies (CBDC), which countries have been working on for several years. Countries have already expressed their intention to compete with the crypto sector using the same technology. Thus, we may see a new front opened against cryptocurrencies with CBDCs.

It’s worth noting that even though the negativity caused institutional investors to exit the market in large amounts in 2022, many financial giants decided to expand their services into the crypto space throughout the year and established various strategic partnerships in this direction. The movement of these companies in the coming year may create the means for institutional money to return to the crypto space, depending on more favorable macroeconomic conditions.

What should not be overlooked is that the troubling events of 2022 are likely to continue in 2023. The crypto industry may continue to be under pressure in 2023 due to liquidity shortages and the fear of contagion.

Source: Investing.com

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