Why are cryptocurrencies crashing? Q&A on Bitcoin, Luna and Other Declining Cryptocurrencies

The cryptocurrency market is seeing one of the worst sell-offs since the market rally in 2020, sparking panic among investors and questioning why cryptocurrency prices are becoming increasingly sensitive to fluctuations in the stock market.

In particular, stablecoins are attracting attention. This type of cryptocurrency, as the name suggests, should have a stable value as the token is pegged to the value of a currency such as the US dollar or a commodity such as gold, providing relative isolation from extreme volatility.

For the record:

May 13, 2022 at 6:42pmPrevious versions of this article stated that the cryptocurrency market cap was $3 billion in November and is now $1.3 billion. The exact figures are $3 trillion and $1.3 trillion.

Stablecoins also fell. What is behind all this? What is the future of the cryptocurrency market? We spoke with finance and investment experts for a broad overview.

Why are Bitcoin and other cryptocurrencies crashing?

Market experts say there are two main factors driving the recent downturn in the cryptocurrency market. The move by the US Federal Reserve (Fed) to combat high inflation and stabilize the market, and the collapse of the so-called stablecoin terraUSD.

  1. Macro Economy: Let’s start with some macroeconomics to explain the first factor. In early 2020, the Fed cut interest rates or borrowing costs to manage the economic downturn caused by the pandemic, essentially putting more money into households and businesses.

    As a result, inflation rose to its highest level in 40 years. Abundant liquidity has also driven prices up in most asset classes, including traditional stock markets and cryptocurrency markets, as traders invest their money in anticipation of stronger returns.

    Rising inflation means economic pain for people. In most cases, our incomes do not rise with prices, thus threatening economic growth more broadly. To contain the damage, the Fed earlier this month raised interest rates by 0.5 percentage points, the biggest rate hike in nearly 20 years. The Fed is also in the process of reducing the money supply to further contain inflation and is expected to continue raising rates in the future.

    Bitcoin price fell below $30,000 for the first time since July earlier this week. Bitcoin is the world’s largest trading cryptocurrency, accounting for more than 40% of the market.

  2. TerraUSD: What has currently caught the eye of cryptocurrency observers is the impact on terraUSD, known by its listing name as UST, and its sister token, luna.

    These are two cryptocurrencies created by Terra Network, a blockchain project developed in Korea. Luna serves as the collateral currency for UST.

What are Luna and UST Cryptocurrencies?

Stablecoins, including terraUSD and luna, are, as their names suggest, touted as a sort of crypto asset that offers more stability during market volatility.

The value of the UST token is pegged to US dollars, which means that one UST token should always be worth $1. When the value drops below $1, the coin is “burned” and can be exchanged for $1 worth of Luna.

According to CoinGecko data, Luna started trading at around $3 in May 2019 and hit an all-time high of around $116 in April.

Earlier this week, the UST broke the peg against the dollar and for the first time 1 UST fell below 30 cents.

What happened to Luna? Why is that a big deal?

As the UST price plummeted, the supply of Luna tokens surged and the price plummeted as large-scale Luna holders became cash. Luna lost 99% of Thursday’s value.

According to Bloomberg IntelligenceThe sharp decline in luna’s value seemed like the worst day in the history of financial instruments, and as cryptocurrency exchanges delisted the coin, there was no liquidity in the market and trading was halted.

Edward Moya, chief market analyst at forex platform OANDA, said a possible reason for the severity of the crash is the specific price structure of the UST token.

UST works differently from other stablecoins like tether backed by government-backed currencies or commercial papers. It is an algorithm-based stablecoin and maintains its value against the dollar using complex methods with the help of luna.

“Most stablecoins keep real assets working, but the algorithmic solution UST had was not able to handle the market volatility seen throughout the bond market. This has led to widespread panic sales,” said Moya.

While the price of terraUSD has fallen to 30 cents, the price of Luna has plummeted from around $81 to $0.00001655 earlier this week. Terraform Labs said on Thursday evening that it would be shutting down the blockchain behind the cryptocurrency and “making a plan to reorganize it.”

The Fed recently expressed concerns regarding stablecoins in its bi-annual financial stability report, saying that a fast-growing sector, which makes up about 15% of the total cryptocurrency market cap, is vulnerable to execution and that risk could leak into traditional markets. said.

Is the cryptocurrency market now behaving like the stock market?

The cryptocurrency market, like the stock market, has been in decline for several months. It peaked in November and all asset markets were corrected as a signal from the Fed’s aggressive liquidity contraction.

Market experts point out that the correlation between the traditional market and the cryptocurrency market is probably at an all-time high. If one plummets, the other will follow or vice versa.

Sylvia Jablonski, Chief Executive Officer and Chief Investment Officer of Defiance ETFs, said the correlation with Nasdaq was 0.82, up from its historical level of less than 0.5 (from 0 to 1). In a similar vein, the traditional market and the stock market are moving in a similar direction than ever, which has a ripple effect on investor sentiment.

Experts observe that the correlation between cryptocurrency and technology stocks, which was one of the stocks most hit by the recent market downturn, is stronger.

Did you think cryptocurrencies were a hedge against inflation?

Some cryptocurrencies, especially the market giant Bitcoin, are touted as assets that retain their value over time, making them a good hedge against inflation.

However, as inflation soared, Bitcoin price halved, making it less attractive to investors during periods of high price rises.

Caleb Franzen, chief market analyst at big data analytics firm Cubic Analytics, said he believes Bitcoin will continue to act as an inflation hedge over the long term. He said that while Bitcoin’s value could drop in the $19,000 to $21,000 range in the short term, it could be a good hedge over the longer term of 5 to 10 years, he said in some modeling projects.

What’s next?

Is Cryptocurrency Heading for the Lehman Era? (Lehman Bros. is a large investment bank that went bankrupt in 2008 and played a leading role in the financial crisis.)

“Not yet. I can’t really say that, especially in cryptocurrency,” said OANDA’s Moya. “There seems to be a potential catalyst, but no systematic risk.”

Franzen believes that a significant rise in the value of Bitcoin could be a harbinger of a rise in inflation that occurred between March 2020 and November 2021.

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