Is crypto repeating the mistakes of traditional finance? S’pore firms shed light on market crash

Bear markets are nothing new. Even in crypto, a space that’s just over a decade old, there have been a number of crashes which have triggered periods of downturn.

The 2013 boom was cut short when China declared its ban on cryptocurrency. The 2017 bubble — which saw Bitcoin break US$20,000 — burst at the hands of regulatory and security concerns, following which, crypto faced a fall worse than the dot-com crash.

Today, the 2021 boom faces a similar demise. History would suggest that this is the expected outcome — no different from the cyclic nature which the market has followed thus far.

However, experts seem to believe otherwise. Here’s why the current crypto winter might be unlike any we’ve seen before.

2022 crypto crash: a perfect storm

Unlike previous market crashes, it is much tougher to pin down the 2022 crash to a particular trigger. There are a mix of market and macroeconomic factors which are contributing to the downturn.

“The situation we are in today differs from the winter of 2018,” says Wayne Huo, co-founder of Singapore-based digital asset company Amber Group. “This time round, there are new factors from the macroeconomic environment at play, with rising inflation levels, recession fears and tightened policies worldwide.”

Gemini crypto exchange’s Andy Meehan cites the higher rate of crypto adoption as another differentiating factor.

“Part of the reason why the latest market downturn feels more impactful is because of the huge rate of cryptocurrency adoption in the past few years. With the greater levels of adoption and investment we are seeing, the impact of this market downturn was felt by a much larger audience.”

A cascading effect

Along with economic and consumer trends, the crypto ecosystem itself is a lot different today as compared to the years prior. Leveraging on concepts such as DeFi and GameFi, hundreds of projects have been established.

From crypto funds to lending platforms, many of these projects relied on each other for their operations. The failures of one project — Terra Luna — have led to the collapse of numerous companies including Three Arrows Capital, Celsius, and Vauld.

All three companies were heavily reliant on market conditions to meet their debt obligations. The unprecedented collapse of LUNA now has them facing the consequences of their risky practices.

Vauld, for example, was forced to suspend withdrawal and deposit services this July amid market volatilty. At present, the company is short US$70 million in debt owed to creditors.

“The crypto winter is showing us just how complex the ecosystem has become and how it is much more interconnected than ever before,” says Huo.

Repeating TradFi’s mistakes

Eddie Hui, COO of MAS-licensed MetaVerse Green Exchange (MVGX) compares this collapse to historical crises seen in the traditional finance industry.

The crypto industry as we know it today, is both privy to and is suffering the same issues facing traditional finance before.

If we look at past financial crises, what we would see was a financial industry that was over-leveraged, fuelled with overconfidence that the bull market would never stop, and with too much trust that some players were too big to fail. It’s unfortunate that the crypto space has failed to learn lessons from the industry it supposedly hopes to revolutionise.

Hui adds that it isn’t DeFi which is at fault for this crash. After all, DeFi protocols and smart contracts have been working as intended.

“I would argue that it was instead human greed and lack of risk management that led to the debacle.”

Bybit’s Igneus Terrenus echoes a similar view. “The collapse of several crypto lending companies is not dissimilar to the kind of collapses that have been part and parcel of bear markets stretching back decades.”

Terrenus cites examples such as Long-Term Capital Management in 1998 and Lehman Brothers in 2008. “They made poor decisions and paid the price when the market turned.”

Still, there’s a silver lining here. Unlike in traditional finance, all the transactions made by crypto lenders can be openly viewed and audited. “Furthermore, when crypto lenders fail, they fail. They don’t get bailouts funded by taxpayers. They live and die by their decisions.”

Crypto, equity markets, and inflation

Another note of similarity with TradFi has been the growing correlation between crypto and equity markets. Crypto’s promise of hedging against inflation and other asset classes hasn’t proven true with the 2022 crash.

“It’s not surprising to see such an increase in correlation, as more institutional capital is flowing into the space,” says Hui. “Cryptocurrencies are still considered risk assets and ultimately, will move along with equities especially when volatility is high.”

Hui believes that it’s not just crypto following equity though. “In some cases, crypto can be a leading indicator of what the stock market will do, as the former trades 24/7.”

Despite this correlation between crypto and equities, Bitcoin — in particular — could still emerge as a safe haven. “Bitcoin has all of gold’s properties as a form of money — scarcity, durability, fungibility, divisibility, portability, and verifiability — and it even beats gold at them,” says Hui.

“Other cryptocurrencies that are less decentralised with virtually no cap on the maximum number of issuances play a different role. Such tokens may be a good speculative play in a bull market, in which performance may beat inflation, but they are not hedges per se.”

Featured Image Credit: Bybit / MVGX / Amber Group / Gemini