Since a market rally in 2020, the cryptocurrency market has experienced one of its worst selloffs. This has caused panic among investors and prompted inquiries about why crypto prices have grown more susceptible to fluctuations in the stock market.
Altcoins in particular are the focus of attention. Because the tokens are connected to the value of a currency like the U.S. dollar or a commodity like gold, they are supposed to have a stable value, as their name implies, protecting users from extremely high volatility.
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Even altcoins experienced a crash. What is the purpose of this? How will the cryptocurrency market develop? For a general overview, we spoke with finance and investment experts.
Why are bitcoin and other cryptocurrencies crashing?
Industry analysts ascribe the recent fall in the quality of cryptocurrencies to two main factors: the collapse of terraUSD, a type of so-called stablecoin, and actions taken by the U.S. Federal Reserve to combat high inflation and stabilise markets.
Macroeconomics: Let’s start with some macroeconomics to explain the first factor. To combat the pandemic-driven economic downturn, the Fed reduced interest rates at the starting of 2020, essentially introducing more money into households and businesses.
As a result, inflation ultimately reached its highest level in forty years. As traders invested their money in expectation of higher returns, there was also a rise in prices across the majority of asset classes, including traditional stock markets and markets for cryptocurrencies.
Since our incomes typically don’t increase in step with prices, rising prices hurt people’s ability to make ends meet and endanger overall economic growth. The Fed increased interest rates by a half percentage point earlier this month, the largest increase in about twenty years, in an effort to contain the damage. In order to further stop the inflationary trend, the Fed is also in the process of reducing the money supply. Rate increases are anticipated to continue in the future.
Investors are uncomfortable due to all of this. Since the start of the year, the Standard & Poor’s 500 and Nasdaq stock indices have decreased by more than 20%. According to data gathered by CoinGecko, a company that studies the market for digital currencies, the market cap of the cryptocurrency industry has more than halved from its peak of about $3 trillion in November to $1.3 trillion at the moment.
Earlier this week, bitcoin’s price fell below $30,000 for the first time since July. The most widely traded cryptocurrency in the world, Bitcoin, holds more than 40% of the market.
TerraUSD: What has cryptocurrency watchers’ focus today now is terraUSD, also known as UST, and how it affects its sister token, luna.
These are two cryptocurrencies made by the Terra network, a South Korean blockchain action plan. Luna helps as UST’s collateral currency.
What are luna and UST cryptos?
Stablecoins, such as terraUSD and luna, were promoted as a class of cryptoassets that provided more stability during market volatility, as the name implies.
Because the UST token’s value is tied to the US dollar, it should always be worth $1. The coin may be “burned” and exchanged for a dollar’s worth of luna if its value falls below one dollar.
According to CoinGecko data, Luna began trading in May 2019 at about $3 and reached its all-time high of about $116 in April, when most other large-cap cryptocurrencies were declining.
UST broke its peg to the dollar earlier this week, and for the first time, 1 UST was worth less than 30 cents, or less than half a dollar.
What happened to luna? Why is that a big deal?
Large luna holders cashed out as the price of UST fell, increasing the supply of luna tokens and continuing to drive down the price. Thursday have seen a 99 percent loss in the value of Luna.
Bloomberg Intelligence claimed that the sudden value decrease of the cryptocurrency luna appeared to be the worst day for a financial product ever witnessed. This led cryptocurrency exchanges to delist the coin, which stopped trading because there was no liquidity in the market.
According to Edward Moya, a senior market analyst at the foreign exchange platform OANDA, the unique pricing structure of the UST token may have contributed to the severity of this crash.
The UST functions differently from other stablecoins, like tether, which are backed by commercial papers or a currency that is backed by the government. It is an algorithm-based stablecoin that relies on luna to carry out a complex process to assure that its value relative to the dollar is maintained.
The algorithmic solution that UST had was unable to handle the market volatility that we are seeing across the bond markets. “Most altcoins will hold actual assets to function. This sparked a widespread panic selling, according to Moya.
The price of terraUSD dropped as low as 30 cents, while the cost of luna fell to $0.00001655, from about $81 earlier this week. On Thursday night, Terraform Labs announced that it had stopped the blockchain powering cryptocurrencies and would “come up with a plan to reconstitute it.”
In its biannual report on financial stability, the Fed recently raised concerns about altcoins, stating that the rapidly expanding industry, which accounts for roughly 15% of the market cap of all cryptocurrencies, is susceptible to runs and that its risks could spread to traditional markets.
Is the crypto market now moving more like the stock market?
As with to the stock market, the price of cryptocurrencies has been falling for several months. All asset markets have experienced a correction since it peaked in November as a result of the Fed’s aggressive signals regarding a tightening of liquidity.
According to market experts, there has never been a stronger correlation between traditional markets and the cryptocurrency market: if one falls, the other will most likely follow or vice versa.
The correlation between the Nasdaq and Defiance ETFs, according to Sylvia Jablonski, chief executive and chief investment officer, is now 0.82, up from previous lows of less than 0.5. (on a scale of 0 to 1). In a similar vein, there is a spillover effect in investor sentiment as both the traditional and stock markets are moving in similar directions more than ever.
The recent market downturn was particularly harsh on tech stocks, so experts are noticing a stronger correlation between the two.
I thought crypto was a hedge against inflation?
Some cryptocurrencies, most notably market leader bitcoin, were promoted as investments with long-term value stability, making them effective inflation hedges.
However, as inflation has increased, bitcoin’s price has more than halved, making it less desirable for investors to hold onto during periods of high prices.
An inflationary hedge for a longer period of time, according to Caleb Franzen, senior market analyst at big data analytics company Cubic Analytics. According to some modelling, the value of bitcoin could fall to between $19,000 and $21,000 in the near future, but over the course of five to ten years, it might turn out to be a good hedge, he added.
What happens next?
Is a Lehman moment on the horizon for crypto? Lehman Bros., a significant investment bank that failed in 2008 and contributed to the financial crisis,
Still not. In the world of cryptocurrencies, especially, you never know,” said Moya of OANDA. “There doesn’t seem to be a systematic risk, despite the existence of potential catalysts.”
According to Franzen, a significant increase in the price of bitcoin could be a sign that inflation will pick up, as it did between March 2020 and November 2021.
What You Need To Know About Crypto Investing
Early investors of cryptocurrencies like Bitcoin, Ethereum, and others have benefited hugely. However, investors are not looking for extreme volatility in a volatile market, which the cryptocurrency market has a long history of exhibiting.
Throughout its history, Bitcoin has experienced several steep declines of more than 80%, with the most recent one occurring in 2018.
Like the majority of other cryptocurrencies, Bitcoin is unrelated to tangible goods or intellectual property, and it doesn’t produce cash flow, pay investors a dividend, or offer an interest rate. Experts claim that because Bitcoin’s price is solely based on supply and demand, it is challenging to determine what it is really worth.
At a recent Berkshire annual investor meeting, CEO of Berkshire Hathaway and renowned investor Warren Buffett discussed Bitcoin’s drawbacks and said he wouldn’t pay $25 for “all of the Bitcoin in the world.”
“I don’t know if it will increase or decrease over the next year, five years, or ten years. But I know for a fact that it doesn’t reproduce and doesn’t create anything,” he said.
It’s possible that over time, the volatility and correlation of bitcoin and other cryptocurrencies to other risky assets will decline. However, the recent price movement in the cryptocurrency market indicates the choppy ride for crypto investors may continue in the near future.
Should You Buy the Dip in Crypto?
Crypto investors should exercise extreme caution when buying the dip.
When asset prices fall as quickly as they have in the cryptocurrency market recently, it can seem like a great time to buy that coin you’ve been eyeing. However, veteran Wall Street traders have a maxim that perfectly captures situations like this: “Never try to catch a falling knife.”
You should be able to imagine that “buying the dip,” or catching a falling knife, almost always results in pain. That is not to say that knowledgeable investors cannot profit quickly by trading during periods of increased market volatility. However, the key takeaway is that sudden, significant market movements can be unsettling for the average retail investor.