Why is the crypto market crashing?

Bitcoin, the asset class that defies logic and is incredibly hard to predict, has been in boom mode for much of COVID. However, there are growing concerns about its future and where the coin is heading as Financial Adviser Brenton Tong explains.

Why is the crypto market down?

We all expected COVID to be the end of the world as we knew it. As flights were grounded and businesses closed their doors, we awaited Armageddon. However, governments and central banks across the globe thought otherwise. Instead, they pumped the global economy with more money than at any point in modern history. Accordingly, many people didn’t suffer the loss of income that they expected. However, they did lose the ability to spend all their money as they used to. People weren’t dining out, seeking experiences, travelling. And for the goods and services they did want to consume, supply chain issues made it increasingly harder to spend.

So what do you do with all that spare cash? Well, many bought crypto. It’s clearly observed that when money is flowing some of it works its way into riskier assets. If you’ve paid down your mortgage, you’ve saved a bit and your retirement savings are steadily growing, why not take a bit of a punt? It’s a clear sign of what is happening when I receive emails from clients saying that have no idea what this crypto thing is, but maybe they should buy some because everyone else is.

With expected changes on the horizon, cryptocurrencies, and Bitcoin have suffered across the market falls. With progression into a post-COVID environment, we’re getting back on with our lives and the global economy hasn’t suffered anywhere near as much as anticipated. This has resulted in a number of factors hitting the momentum that crypto has experienced over the past few years.

What is causing the crypto market to lose momentum?

Government policy

Firstly, an anticipated tightening of both monetary and fiscal policy by governments and central banks globally has hit the money supply. This alone isn’t enough to stop or drop an asset, but it takes a little bit of the momentum off the table. We’ve similar falls across much of the tech sector – and while not tightly correlated, it’s easy to see that investors are being a little more cautious in how they allocate their capital. People buy risky assets to make money, and it takes a constant increase in capital to see prices rise. When that capital slows down, the gains are no longer there and investors start to consider if they’re going to get the future gains that they were expecting. Some will exit and take their profits off the table.

China crackdown

Then we had China’s crackdown on crypto services. China is very wary of crypto as the controlling party likes to be able to monitor and control the flow of money around and into/out of the country. A decentralised and unregulated currency runs contrary to what the communist party wants, so they have been taking steps to crack down on the services that supply it. Given the size of the Chinese economy, this also has a negative effect on the market.

War in Ukraine

Next, we’ve had the war in Ukraine. Interestingly, cryptocurrency is playing a role in this war as it’s an easy way to circumvent the sanctions that the west is throwing at Russia. However, unlike investors holding onto their crypto waiting for price gains, the interesting outcome of the war with Ukraine is that crypto is being used for what it was originally intended – a deregulated and decentralised medium of exchange. What this means for the market is that while the number of trades into and out of Russia has increased significantly, many of the buyers are subsequently selling and cashing out into other fiat currencies. This doesn’t add a lot of weight to the market, however, does help to solidify the larger cryptocurrency coins as genuine global transaction tools.

High leverage levels

As cryptocurrency has become more mainstream and the gains have constantly fuelled attention on the asset class, investors have also been leveraging up and borrowing money to fund their purchases. While borrowing money to invest can be a good thing, it can sometimes lead to the investor’s hand being forced into a selling position if their trade goes the wrong way. Leverage levels hit a high in January of this year, however with falls in the market, it’s likely that the unwinding of leveraged positions helped to speed up the fall as more forced sales were triggered.

Security breaches

While it’s only likely to lead to short term downwards pressure on the market, security breaches have been problematic since the inception of the blockchain-based currency. However, as prices have risen over the years, the incentive for hackers to go after less secured wallets just gets bigger and bigger. Often, rather than targeting a single wallet, hackers will go after an entire exchange or other cryptocurrency infostructure. The fallout from a successful hack, however, is that a lot of money goes missing from a lot of people and word gets out quickly about what has happened. Investors tend to recover from this over time, however, it does lead to a drop in demand for new buyers as they worry about the security of investing. As the coins are not traceable, they can then be easily cashed out after the hack, leading to further selling pressure and price falls.

Will the crypto market rise again?

What does the future hold for cryptocurrency and the bitcoin price? Time will tell. Despite the size of the market and the increasing popularity of cryptocurrency, it’s still a tiny market in global terms. The total value of cryptocurrency today is around $2.1 trillion dollars. While that might sound like a lot of money, the likes of Apple, Microsoft or Saudi Aramco are individually worth more than that. On a global basis, that’s pretty small. It doesn’t take much to move such a small market one way or another – so the future of crypto prices really comes down to broader adoption and continued buying from investors to drive up the price. If people, en masse, start to think that it’s had its day and the future isn’t bright, it’s not sufficiently embedded into the global markets to survive that. However, if just a fraction of the globally investable capital finds its way into the crypto markets, we’ll see its continued expansion.