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The cryptocurrency world is in chaos.
It was just a few months ago that crypto companies were doing a lot of Super Bowl advertising after virtual currencies experienced a dizzying rally in 2021.
Today Bitcoin and other cryptos are plunging, and companies such as Coinbase, which runs the largest crypto exchange in the United States, are announcing layoffs.
“The crypto house is on fire, and everyone is racing for the exits as there is a complete loss of confidence in the space,” says Ed Moya, senior market strategist at financial firm Oanda.
Here’s what happens.
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 rate in more than four decades, and the Federal Reserve is aggressively raising interest rates to bring down 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 are making borrowing costs more expensive for individuals and businesses, raising concerns of an economic recession.
Stocks have fallen dramatically 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 peak).
Cryptocurrencies have hardly been spared. Since Bitcoin hit an all-time high in November, the value of the world’s most popular digital currency has fallen around 70%, and its rivals are also suffering. Ether is down about 70% this year, as is Dogecoin.
Bitcoin proponents have always claimed that the digital currency would be an “inflation hedge”, but in fact it hasn’t behaved that way.
As shares of tech companies fell, the value of Bitcoin also fell.
“What this episode, this crypto price crash, shows is that cryptocurrencies are by and large speculative financial assets 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 cryptocurrency businesses?
The sharp falls in cryptocurrencies are putting some companies in trouble.
Celsius, which takes cryptocurrency deposits from individuals and lends them out, stopped withdrawals as it faces financial problems. Binance, a cryptocurrency exchange, halted bitcoin withdrawals for several hours on Monday.
The Celsius issues are undermining confidence in the broader cryptocurrency space just weeks after a stablecoin called TerraUSD collapsed.
Crypto companies are responding by reassessing their plans for the future.
Coinbase, a cryptocurrency exchange, has cut its staff by almost a fifth.
In a note to staff, the company’s CEO said Coinbase “has grown too quickly.”
“We appear to be entering a recession,” wrote Brian Armstrong.
Some cryptocurrency proponents still believe that a “crypto winter” could lead to a “crypto spring.” In the past, deep recessions have led to strong rebounds.
But according to Moya, an analyst at Oanda, the economic landscape is different now, as is the outlook for crypto.
In fact, with the Fed continuing to raise interest rates aggressively and with inflation still high, there is likely to be more pain ahead in all markets, including cryptocurrencies.
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How much does this mean for those who got into crypto?
It’s been a wake-up call for the millions of people who have bought into cryptocurrencies, especially if they fell into the craze last year.
Prasad says 2021 has been “the height of crypto mania”.
The total value of all digital currencies in the world has reached $3 trillion. Crypto companies have signed sponsorship deals with professional sports teams, and Coinbase, Crypto.com, eToro, and FTX have 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 crypto is the future of finance and best not to miss it.
“The technological glare of cryptocurrency attracted 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 been reduced to around $1 trillion. And if you bought Bitcoin on February 14, the day after that Super Bowl advertising bargain, it’s now worth about half of what you paid.
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What will this mean for the regulation of the sector?
The increase in the number of amateur investors, combined with the growing complexity of some cryptocurrency products, has regulators worried.
Crypto markets are still relatively new and there is a lack of clarity on even the most basic things, like who is in charge of overseeing the space.
Currently, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) claim oversight of parts of the crypto market.
“If there’s no guidance, people will be taken advantage of, and we want to prevent that,” says Duke University finance professor Cam Harvey. “At the moment we have practically nothing.”
SEC Steps Up Enforcement Actions Against Crypto Firms, Considers New Rules. Meanwhile, in an executive order, President Biden asked government agencies to make policy recommendations.
And in Congress, Senator Cynthia Lummis (R-WY) joined forces with Senator Kirsten Gillibrand (D-NY), on the first comprehensive crypto legislation. The bill would give more regulatory power to the Commodity Futures Trading Commission.
Yet, for now, many analysts do not believe the financial system as a whole is in danger. The total value of the cryptocurrency market is always less than the total market value of a large company like Apple.
But this recent downturn has raised serious concerns.
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