Don't buy or sell crypto in 2023 before reading these five facts
This crypto-winter is unlike any before. Despite the scale of wealth burnt, the lessons from the past are no indicator for the future.
The market for crypto-assets has taken a serious hammering in 2022. Small investors and entrepreneurs alike have seen their wealth crumble. Even if we ignore those directly affected by the FTX-fiasco – of which there are many – the destruction of wealth is extraordinary. Two of the richest crypto-leaders serve as a superb illustration. Within the year Binance-founder Zhao’s net worth fell from $96 bn to $4.5 bn and Coinbase-founder Armstrong’s fortune was slashed from $13.7 bn to $1.5 bn. But this is no typical crypto-winter. Not least because of the scale, many are asking: Is there a future at all for cryptos or will 2023 end the hype once and for all?
I will argue that while we will probably see several more months of turmoil the current crypto-winter is not as threatening to the industry as previous ones. The technology and the industry have matured up to a point where even such setbacks as FTX and Terra/Luna are no existential threats. Many indicators show that the space has built a remarkable resilience.
1) The scale of the crash is overblown.
There is no sign of crypto-Armageddon yet. Trouble – sure. But the impact is nowhere nearly as devastating as the media-coverage would make you believe. According to Coinbase the total cryptocurrency market cap fell by 62% to $835 bn.
Consider two things. First, this is historically still one of the highest volumes the crypto-assets market has ever stood at. Second, other asset classes have been hit hard by the economic downturn too. Nasdaq has shed 30% of its value in 2022 while being composed of stocks much less-volatile than cryptocurrencies. Individual stocks like PayPal or Tesla have performed even worse, let alone privately-funded fintechs. In that light the crypto-slump seems to have more in common with tech-stocks than with speculative assets. Coinbase also points out that unlike in the last crypto-winter, this time BTC and ETH performed even better than US-bonds and in line with stock-indices on risk-adjusted returns.
2) Institutional backers are deeply involved.
One reason why crypto-assets have not plummeted the way many have predicted is because of the firm institutional entrenchment that exists today. Many firms and asset managers have discovered crypto-assets (in particular BTC and ETH) as an important pillar of their long-term portfolios. This long-term approach is also demonstrated by a survey that asked institutional investors about their outlook on crypto-prices over the next 12 months. 53.6% of the respondents expect them to hover at approximately where they are now.
Institutional investment capital is important in and of itself, but it has granted the industry also another level of legitimacy. Trusted players have established ways of dabbling in the crypto-industry with strong on- and off-ramps that are enabling oversight.
Moreover, companies are going big on blockchain technology more broadly. This is per se not connected to cryptocurrencies, but many institutions are tokenizing assets and also keeping track of them via decentralized, public blockchains. Big lenders such as Société Générale or DBS Bank tokenize traditional financial assets to bring them onto chains such as Polygon. This adds another additional element of stability that was missing in previous crypto-winters.
3) The FTX-meltdown will accelerate long overdue regulation.
Today trust in regulators is at a low-point and this is especially personified in the SEC chairman Gary Gensler. While he was chasing the likes of Kim Kardashian to create the maximum publicity out of a minor misdealing, investors lost fortunes in cases like Voyager, Celsius, Terra, and now FTX – all fiascos that shook the crypto-world in 2022. Gensler’s political backers will be having a hard time to keep him in that important position.
Unfortunately, oftentimes many people have to lose their money before regulators get serious about establishing necessary rules and oversight, or at least start clarifying which regulator is actually in charge of what. We have probably reached that point now.
The good news is, there are a number of bills on their way on both sides of the Atlantic. In America the McHenry-Waters draft bill is expected to clarify open questions around stablecoins. The Digital Commodities Consumer Protection Act (DCCPA) should empower the CFTC to oversee digital assets spot markets. In the European Union the Markets in Crypto Assets Regulation (MiCA) is already showing banks and companies the way even before being ratified. And in the US there is bipartisan support for the major efforts.
4) Stablecoins are bigger than ever.
Stablecoins already make up 17-18% of the entire crypto-market. Taken together with BTC and ETH they cover an incredible 78% of all crypto-asset market volume. On top, a very special type of stablecoin, namely CBDCs, are about to enter and jumble the market. Those are digital currencies issued by central banks that represent a blockchain-based version of fiat. They are no investment asset, but as soon as large CBDCs start to flood the market it will lead to an influx of capital into the decentralized finance space. They will supply liquidity for all types of autonomous, blockchain-based financial transactions.
Stablecoins are called like that because they keep their value pegged to a stable asset, but they also add stability to the crypto-market more broadly. The success of stablecoins shows a number of reassuring trends. First, huge amounts of wealth are parked in stablecoins and ready to be re-invested once the market-outlook turns brighter. Second, all those stablecoin holders trust the ecosystem. Third, the proliferation of stablecoins goes hand-in-hand with the proliferation of decentralized finance, which is a much more sophisticated use of crypto-assets than just holding them. Fourth, the popularity of stablecoins demonstrates impressively that blockchain is not, like many of its critics claim, a solution in search of a problem but that it boasts advantages over traditional means of transactions.
5) Market concentration indicates an increasingly established market.
As described in the previous section, the market is concentrating around BTC, ETH, and stablecoins. This trend is typical for every maturing market. A major milestone for it was achieved last year. Overshadowed by the headlines of fraud and other missteps in various crypto-projects, one extremely important success story of 2022 went largely uncovered by the general media: The Ethereum merge. The largest smart-contract-enabled blockchain swapped its consensus mechanism from Proof-of-Work to Proof-of-Stake by merging the consensus and execution layers. It thereby slashed the energy consumption by 99,9% and proved that future upgrades are possible.
The consensus mechanism is basically the heart of every blockchain, so the significance of this achievement is immense. Compare it to a bank that wants to replace its core banking system, only that there is no central authority coordinating and executing the swap. It is simply unthinkable.
The crypto-sphere is obviously only a minor application field of blockchain technology. Whether it stays alive will have no ramification on whether companies will utilize blockchains and distributed ledgers. It will, however, determine how vibrant many (novel) use cases in finance will become, including the entire digital-asset class.