If you have read any news about cryptocurrency in the past two months, chances are it was negative press about cryptocurrency’s recent crash. However, while many headlines indicated a general state of pessimism as prices dropped, the crypto market’s current downturn appears to be a building block for its successful future. Since the start of the new year Bitcoin has lost 20% of its value, falling from $48,000 to $37,000 per coin. Other major coins such as Ethereum, Cardano, and Solana have followed the same trend of a 20-30% price decrease as the whole cryptocurrency market is beginning 2022 with a steep drawdown. While this type of crash may seem reminiscent of the Great Crypto Crash of 2018, this market downturn has put cryptocurrency and blockchain in a different situation that sheds light on the future price movements of major coins and gives blockchain (specifically DeFi) an opportunity to come out of the downturn stronger than ever.
Before I analyze the current cryptocurrency downturn, I will define key terms I will be using as well as explain cryptocurrency’s 2018 price crash. Bitcoin will be a focal point of my discussion since it is the largest coin with a market cap of $750 billion, and one of the main indicators of the cryptocurrency market. Created in 2009 by Satoshi Nakamoto, Bitcoin is a virtual currency whose transactions are recorded on a public ledger known as a blockchain. The blockchain shows the transaction history for every unit of Bitcoin and therefore acts as proof of ownership. Ethereum, although commonly misrepresented as simply a virtual currency like Bitcoin, is actually an ecosystem. In addition to the Ethereum coin being the second largest coin with a market cap of around $300 billion, Ethereum is also a decentralized platform where users can build distributed applications (Dapps for things like holding cryptocurrency), create smart contracts, and build decentralized autonomous organizations (called DAOs). This blockchain ecosystem, called DeFi, acts as a source of decentralized finance in which individuals can do anything with their money that they would usually do through a centralized bank, but on a decentralized shared infrastructure.
Cryptocurrency’s recently negative activity has motivated discussions about one of the most grim periods in cryptocurrency’s short history. In January of 2018 there were wide sell-offs as people dumped their cryptocurrency holdings into the market for fear that they had reached their value ceiling after a boom in 2017. This caused one of the worst crashes in virtual financial history: by November 2018 Bitcoin and other major coins had fallen 80% from their peak in 2017. This prolonged and disastrous crash had widespread effects on the cryptocurrency and blockchain space. Many platforms and new coins went underwater, country legislators such as those in South Korea threatened to ban cryptocurrency trading, and groups of hackers took advantage of the spaces’ vulnerability.
Today’s cryptocurrency crash shares many of the same characteristics with 2018’s. Both occurred at the start of the new year as a result of sell-offs after a banner year of growth in value and popularity, but the similarities stop there. The main concentration of sell-offs this year happened in early to mid January with Bitcoin prices plunging 20% between January 1 and 25, but unlike in 2018, these drastic sell-offs were not unique to the crypto market. All risk assets got crushed at the start of 2022 with growth tech stocks in particular experiencing a similar downturn. Low prices and high volatility, something long associated with cryptocurrency, were not isolated to the crypto market with the Nasdaq composite (an index including every company which publicly trades stocks) dropping 14% and the NDXT composite index (a technology sector index) decreasing by 17% in the first 27 days of the year. Equities as a whole, specifically tech equities, crashed in prices on a similar trend as crypto, revealing a newfound coupling of cryptocurrency prices and tech equity values. With unprecedentedly high inflation and a federal reserve which is struggling to combat it, crypto’s bear market is not unique, showing how crypto has transformed from an extremely volatile asset in 2018 to a risk asset that is coupled with growth tech stocks and relatively falls in line with the market as a whole. I do not see this strong of a correlation lasting for an extended period of time —there will likely be a slight decoupling between crypto and equities in the near future as both bounce back, but a major decoupling can only happen in 4-5 years when blockchain is truly seen as something different than an extension of the internet. While a true diversification between crypto and growth tech is relatively far away, one of the main reasons I anticipate crypto slightly outperforming growth tech stocks in the near future is because of what happened to DeFi systems during the current downturn.
During the increased sell-offs, all DeFi systems were put to the extreme test as they had to handle vast amounts of liquidations from millions of transactions from thousands of users. In the cryptocurrency space there are many ecosystems that support DeFi and some handled liquidations much better than others. Notably, the Solano ecosystem had uptime issues processing transactions and its flaws as an unfinished platform were exposed. Specifically, Solana does not have a fee market like other blockchain ecosystems, meaning they do not operate on a gas model like the Ethereum ecosystem. Gas fees are transaction fees paid to Ethereum miners to verify transactions securely, and their price is dependent on the type and size of the transaction. Since Solana has a fixed fee for every transaction, there was no way to tell the blockchain which transactions were important and needed to be processed, creating a backlog of transactions that started to weigh on the ecosystem and cause uptime issues. Ethereum and other ecosystems like Pyth and Cosmos which don’t operate on a fixed fee platform did extremely well, showing how DeFi can succeed even when liquidations are at their highest. The mostly successful response of DeFi during the crash shows that while there are still necessary improvements to ensure DeFi is always on a live blockchain, systems built on solid models are reliable. The reliance of these DeFi blockchains casts cryptocurrency in a new light as something that is much more stable and not vulnerable to price volatility.
As the market as a whole rebounds in the next few months, it appears as though the cryptocurrency market has bottomed out after two months on a downward trend. As prices recover in the short term, major coins such as Bitcoin and Ethereum will experience healthy growth on a similar trend as growth tech. Due to newfound proof of DeFi’s reliability, crypto has the ability to slightly outperform the tech associated risk assets and continue to grow as it works towards a total decoupling from growth tech in five years time when blockchain is more fully understood as the new age for technology.