Cryptocurrencies in Perspective

25 May 2022

Cryptocurrencies have been a hot topic over the last few months, increasingly brought into the news by first the war in Ukraine and more recently by the steep price falls over the last few weeks. We therefore asked an analyst at GlobalBlock to provide a high-level market insight:

What has caused the current crash in crypto prices?

The sell pressure seen in crypto can be explained in terms of the aggressive tightening of monetary policy by the Federal Reserve (the central bank of the USA) in response to 40-year high inflation.

Throughout 2020 and 2021 the Federal Reserve supported the markets by injecting liquidity which led to exceptional performance in both crypto and equities. Now the Federal Reserve is raising interest rates to combat inflation. Quantitative tightening will begin in June, the Federal Reserve will start removing liquidity from markets, and this is currently being priced in. Crypto is heavily affected by the Federal Reserve’s actions because it is deemed to be high risk by the majority of investors, hence it correlates with other assets whose valuations rely on expectations of future growth known as risk-on assets, which struggle when macro headwinds such as inflation are at play.

The TerraUSD (“UST”) stablecoin which was worth USD18 billion collapsed last week, leading to further sell pressure in the crypto markets and adding to the fears surrounding inflation.

UST is an algorithmic stablecoin, whose value is linked to the US dollar. UST acquired various crypto assets including USD3 billion worth of Bitcoin for its reserves to support the value of the peg against the US dollar when investors needed to sell. In an attempt to release cash to support the UST peg at USD1 the project team sold its USD3 billion worth of Bitcoin reserves, which caused panic in the market.

UST was adopted by many funds, Venture Capitals (“VCs”) and Decentralised Finance (“DeFi”) protocols, so we will soon find out what the full impact of this collapse on the rest of the industry has been and whether it will cause other crypto businesses/projects to fail.

The impact on the market now and in the future?

In the short-term, we will find out the extent to which various crypto companies have been affected by the UST stablecoin collapse, and if there are any systemic issues as a result.

The key driver for where the market is headed in the medium-term (next six months) will be led by inflation. If inflation slows, the Federal Reserve will be less aggressive in their monetary policy and the selling pressure on crypto from quantitative tightening will lessen. However, if inflation continues to run at high levels the Federal Reserve will need to continue tightening monetary policy and crypto prices will face further headwinds.

The direction of the crypto markets in the long-term (next five years) will be dependent on institutional adoption that can allow crypto to reach the mainstream. The institutional interest demonstrated by big tech companies such as Instagram and Twitter integrating Non-fungible Tokens (“NFTs”), and international banks such as Goldman Sachs offering cryptocurrency services, suggests that user growth could continue to surge over the coming years.

What are the key drivers that affect the fluctuations in price?

Bitcoin’s price is heavily correlated to tech stocks currently, due to the macro headwinds at play. These tech stocks represented by the Nasdaq are affected by inflation data and the decisions of the Federal Reserve. As an example, if the Federal Reserve takes a more aggressive stance on interest rates, this will negatively impact the Nasdaq and therefore crypto.

Altcoins (cryptocurrencies that are not Bitcoin) correlate highly with Bitcoin whilst it is in a downtrend, but with greater volatility, which is what we are seeing currently. When Bitcoin is in an uptrend, altcoins are less impacted by Bitcoins’ movements, and fluctuate based on the user growth of their networks. In addition to user growth, market trends play a significant role in the direction of many altcoins. E.g., the metaverse trend during Q4 last year led Sandbox (“SAND”) to rally ten times in two months.

Background to Cryptocurrency provided by a Martello Expert:

Cryptocurrencies are a form of digital currency with unique properties. Like any other currency, cryptocurrencies can be used as a medium of exchange, a store of value or as a speculative investment. In contrast to traditional bank deposits, cryptocurrencies are maintained on immutable distributed ledgers that operate on a peer-to-peer basis and are not directly controlled by centralized intermediaries. The most well-known cryptocurrencies are Bitcoin and Etherium. These run on public blockchains where every transaction ever made is accessible to anyone with access to the internet. Accounts may be opened freely, and transaction charges are subtracted by ‘miners’ who perform transaction verifications before they are recorded.