Cryptocurrency Falls from Its Altar

In the past few years, cryptocurrencies have been very popular. Although the market is always full of doubts or pessimism about cryptocurrencies, this does not affect the continuous growth of its overall market value, and more and more mainstream institutions have also included it in the category of investment assets.

According to Statista, there were 10,397 cryptocurrencies in February 2022, compared to 4,501 in February 2021, a year-on-year increase of 230%. According to Coinmarketcap, in November 2021, the market value of cryptocurrencies approached $3 trillion.

However , since 2022, cryptocurrencies have been on a downward trend.

Since the beginning of the year, mainstream cryptocurrencies have all suffered a massive decline. Except for stablecoins, the decline of currencies ranked higher in market value is mostly in the range of 40%-60%. The overall market value of cryptocurrencies is currently close to 1.29 trillion US dollars, down more than 54% from the highest point last year.

Figure 1: Overall cryptocurrency market capitalization (2013 to 2022)

Source: Coinmarketcap

1. Reasons: Why did cryptocurrency suffer a "Waterloo"?

2022 is a year full of uncertainty. We have not yet completely emerged from the atmosphere of the epidemic. The huge changes in the international economy and geopolitical conflicts are affecting the entire economy, and the cryptocurrency industry, which is controversial in itself, is "hit by the gun."

1. The Fed raises interest rates

On March 16, Eastern Time, the Federal Reserve announced its interest rate decision under the watchful eyes of the public, raising the benchmark interest rate by 25 basis points to a range of 0.25%-0.50%. This is the first rate hike by the Federal Reserve since December 2018.

On May 4, the Federal Reserve announced another 50 basis point rate hike, raising the target range of the federal funds rate to between 0.75% and 1%. This is the first time since 2000 that the rate hike has reached 50 basis points.

According to the dot plot released by the Federal Reserve , 75% of officials expect six more rate hikes this year, bringing the benchmark interest rate to around 1.9% by the end of 2022 (the median estimate of Federal Reserve officials).

The Fed's interest rate hike has caused a short-term or long-term liquidity crisis. As the global economy tightens, capital allocation is more inclined towards safe and stable assets. In addition, the repeated COVID-19 pandemic has caused the global economy to recover slowly, the stock market to fluctuate, the international political situation to become tense, and the entire market to fall into a trough. Global capital is facing a new distribution situation, and cryptocurrencies are more severely affected by uncertainty than mainstream assets.

The reduction in liquidity caused by the Fed's interest rate hike is a heavy blow to cryptocurrencies, causing the overall trend of the entire cryptocurrency market to decline, and even some relatively stable cryptocurrencies have fallen. On the other hand, the Fed's interest rate hike has increased the negative sentiment of the global economy. Cryptocurrencies react strongly to uncertain events or emergencies. When events such as the Russia-Ukraine dispute or the sharp drop in LUNA coins occur, the panic in the entire market doubles and spreads, causing the entire cryptocurrency market to be sluggish.

CoinGecko co-founder Bobby Ong predicts that the crypto market will be challenging in the next 12 to 18 months as the Federal Reserve raises interest rates to curb inflation and is now at the beginning of a rate hike cycle. In addition, cryptocurrencies such as Bitcoin are now closely related to traditional finance and are seen as technology stocks/risk assets, so a stock market decline will also have an impact on the crypto market.

The same is true when looking at the performance of traditional capital markets and cryptocurrency markets.

Since the beginning of 2022, the overall performance of the A-share market has been negative. However, among them, the increase in US crude oil has reached 49.55% since the beginning of the year. Bank of America stated in its 2022 "Commodity Outlook" report that strong demand, low inventory and economic decarbonization measures will support commodity prices. With the rise of global risk aversion, London gold has now risen by 2.50% since the beginning of the year. In addition, the yields of other major global stock indices are between -10% and -20%.

The overall trend of cryptocurrency this year is far worse than that of the mainstream capital market. The year-to-date returns of cryptocurrencies are mostly between -30% and -60%. The year-to-date returns of Bitcoin and Ethereum are -36.92% and -46.66% respectively. The declines of DOT, LINK and CRO exceed 60%.

Figure 2: Comparison of the performance of digital currencies and traditional capital markets (as of May 25, 2022)

Data sources: 01 Blockchain, Coinmarketcap, Choice

2. Russia-Ukraine conflict

In late February this year, the Russian-Ukrainian dispute broke out. When US President Joe Biden said that Russia had decided to invade Ukraine and a military strike could take place within a few days, Bitcoin subsequently fell off a cliff.

However, as the Russian-Ukrainian conflict unfolded, Bitcoin began to rebound from its lows, with some analysts attributing the cause to investors buying the dip and Russians and Ukrainians converting to Bitcoin to protect their wealth.

Figure 3: Comparison of Bitcoin, Gold, and U.S. Treasury Bond Price Trends

Source: Refinitiv Datastream

In this Russia-Ukraine dispute, cryptocurrencies have also "joined" the war.

On the one hand, Ukraine received donations in the form of cryptocurrencies during the war.

Alex Bornyakov, Ukraine's Deputy Minister of Digital Transformation, praised the role of cryptocurrencies in helping Ukraine. He believes that the traditional banking system is too slow to provide the necessary funds for military and humanitarian aid, and stressed the importance of cryptocurrencies to respond quickly in special moments.

The Ukrainian government's official Twitter account announced that it was accepting cryptocurrency donations. In less than two weeks, the cryptocurrency donations received exceeded $100 million, of which the Ukrainian government's official address received a total of about $48.55 million in cryptocurrency. On the official cryptocurrency donation website "Aid For Ukraine", more than $50 million in funds have been raised.

In terms of policy, Ukrainian President Zelensky officially signed the "Ukrainian Virtual Assets Law" on March 16, legalizing cryptocurrencies such as Bitcoin, clarifying that foreign and Ukrainian cryptocurrency exchanges will operate legally, and banks will also open accounts for crypto companies.

On the other hand, Russia also uses cryptocurrencies to break through financial sanctions.

In this conflict, Russia faces sanctions from the United States, the European Union, the United Kingdom, and Canada, including a promise to remove selected Russian banks from the SWIFT system, which is equivalent to directly cutting off Russia's cross-border capital network. Although Russia claims that its central bank is developing a replacement system for SWIFT, SPFS, this still cannot change the situation that Russia is greatly constrained in international payment transfers.

Through cryptocurrency, Russia can significantly improve its ability to resist sanctions. Public data shows that Russia is the world's third largest Bitcoin mining country, accounting for about 12% of the global crypto market. A Russian government report estimates that there are more than 12 million cryptocurrency wallets opened by Russian citizens, involving a total of about 2 trillion rubles. This means that cryptocurrency occupies a significant proportion of the Russian financial system.

Ross S. Delston, an American anti-money laundering compliance expert, said, "If the Russians decide not to use any currency other than cryptocurrencies, they can effectively avoid almost all sanctions." Alexander Yakubovsky, a Russian congressman and member of the Crypto Legislation and Supervision Working Group, also said that the "legalization" of encryption can help Russia fight Western-led economic sanctions.

In addition, on March 24, Pavel Zavalny, chairman of the State Energy Committee of the Russian Duma, said that Russia is willing to accept Bitcoin as a payment method for its natural resource exports. This method is trying to find an outlet to break the blockade of the US dollar.

On the other hand, the United States and its allies are also preventing the evasion of sanctions through cryptocurrencies.

On March 1, the U.S. Treasury Department officially included crypto asset regulations in its sanctions guidelines against Russia. The new regulations include prohibiting Americans from providing any support to Russian oligarchs and entities, including through transactions using digital currencies or assets. At the same time, the U.S. Treasury Department requires Binance, FTX, and Coinbase to block sanctioned persons and addresses.

Under the "consensus" to prevent Russia from using cryptocurrencies to evade sanctions, G7 countries said they are studying ways to prevent Russia from using cryptocurrencies to evade sanctions. The European Union proposed that it would provide guidance on cryptocurrency regulation to avoid being used to circumvent sanctions. The Japanese government and financial regulators have issued policies to punish crypto exchanges that do not comply with Russian sanctions.

3. Implosion of the Stablecoin UST

As the war situation between Russia and Ukraine stabilized, cryptocurrencies had just crawled out of the quagmire of political disputes, but have begun to fall to the bottom again since May.

On May 12, cryptocurrencies experienced a "Black Thursday." According to Coinmarketcap, a cryptocurrency price tracking website, the market value of cryptocurrencies evaporated by $200 billion in one day, and Bitcoin fell to as low as $25,401.29 that day. The Los Angeles Times website called it "the cryptocurrency market is experiencing the worst sell-off since the market rebound in 2020."

The direct cause of this cryptocurrency decline was the implosion of the “Earth” dollar stablecoin UST.

UST, or TerraUSD, is an algorithmic stablecoin launched by the Terra blockchain. Stablecoins can be seen as a cryptocurrency with an "anchor" attribute, that is, it achieves value stability by anchoring mainstream currencies. In order to maintain the growth of UST, the Terra ecosystem launched LUNA, also known as the "Moon Coin".

UST is anchored to one dollar through the LUNA currency. In the Terra ecosystem, LUNA can be freely exchanged with UST. When the price of UST is higher than one dollar, users can exchange UST for LUNA and earn the difference of one dollar by destroying UST. At this time, the supply of UST decreases and the price tends to be tighter towards one dollar. Vice versa.

Previously, in order to increase its usage, the project team of UST gave a large amount of deposit subsidies, and the interest rate for depositing UST was as high as about 20%. As the high interest subsidies given by the government were almost used up, investors began to withdraw early, resulting in the selling of UST. When the price of UST was lower than one dollar, a large number of people holding UST switched to LUNA to cash out. As the market run became more and more intense, the Terra blockchain network could not bear the destruction of UST and minting of LUNA in a short period of time, causing the stablecoin mechanism to fail.

From the price trend, before this irreversible price depegging event, the price of UST was stable at one dollar, but since May 10, its price has fallen and is currently maintained at around $0.06. From the price trend of LUNA, it was close to $120 in April this year, but now it has almost returned to zero.

Figure 4: UST price trend

Chart source: Coinmarketcap

Figure 5: LUNA price trend

Chart source: Coinmarketcap

One stone caused a thousand ripples, and the entire cryptocurrency market plummeted.

The sentiment surrounding the plunge in UST and LUNA quickly stirred up the entire cryptocurrency circle, causing a collective plunge in cryptocurrencies.

On the one hand, the institutions behind UST have hoarded a large amount of Bitcoin. It is reported that the cryptocurrency company Terra purchased more than $3 billion worth of Bitcoin to support its failed stablecoin. At present, UST has not shown any signs of "survival", and the institution may be forced to change from a large buyer of Bitcoin to a large seller in the future.

On the other hand, confidence is sometimes more important than gold, and the loss of confidence has brought about a chain reaction of falling prices of mainstream cryptocurrencies. As a stablecoin, it should be the safest and most stable cryptocurrency, but this collapse indirectly shows that cryptocurrencies have weaknesses in mechanisms and algorithms, and lack the endorsement of centralized regulatory agencies, making it difficult to cope with sudden crises.

2. Outlook: Where will cryptocurrency go?

In April 2022, a 92-hour crypto feast was held in Miami Beach, where industry giants such as Twitter and Square CEO Jack Dorsey and MicroStrategy CEO Michael Saylor gathered together, attracting 25,000 crypto believers to participate. To commemorate the city's preference for cryptocurrencies and the digital asset industry, Miami also held an unveiling ceremony for a bull statue, openly "provoking" Wall Street. Everyone present discussed how cryptocurrencies will go from fashion to mainstream.

In May, the Mapo Police Department in South Korea sounded the alarm and strengthened daily patrols in places such as the Mapo Bridge, hoping to detect and prevent suicides in time. The Mapo Bridge is close to Yeouido, where securities firms and investment institutions are densely populated. It was previously a popular suicide spot in South Korea. According to Korean media reports, the number of searches on the Internet about "Mapo Bridge" has increased significantly, especially those related to LUNA coins.

Is cryptocurrency heaven or hell? Where will it go in the future?

1. Is Bitcoin digital gold?

The mechanism of Bitcoin production is similar to that of gold. The total amount of Bitcoin is set at 21 million, and it is produced through "mining", that is, a large amount of calculations. As more Bitcoins are produced, the difficulty of mining will also increase. At the set rate of halving the output every four years, it is expected that all Bitcoins will be mined in 2140. The limited total amount and the gradually increasing difficulty of mining make it "scarce" like gold, and it is also called "digital gold" by cryptocurrency supporters.

In addition, unlike fiat currencies that rely on national credit endorsement, the issuance and operation of Bitcoin are all based on code. This means that Bitcoin is not affected by sovereign politics, and holders will not lose wealth due to exchange rate fluctuations or central bank money printing. This feature is particularly important in the context of escalating geopolitical tensions.

“The fact that it can’t be frozen, it can’t be censored, and it can be used without an ID is very, very important, and that’s why Bitcoin is such an important humanitarian tool.”

—Alex Gladstein, Chief Strategy Officer, Human Rights Foundation

In several political conflicts in recent years, the voices of support for "digital gold" have become louder and louder. In early 2020, the conflict between the United States and Iran broke out, and the price of Bitcoin once rose by more than 20%. In late 2021, the collapse of the Turkish currency Lira promoted the prosperity of Bitcoin. Data shows that Bitcoin, which once had a market price of US$55,000, is priced at US$100,000 in offline exchanges in Turkey, which shows the strong demand for cryptocurrencies among citizens in the crisis.

However, this year, when faced with various macro-environmental influences and emergencies, Bitcoin has not shown the same stable value as gold, but has fluctuated violently. And when the political situation involves sovereign states, Bitcoin cannot "stay out of the mud" in the political quagmire. As far as the current situation is concerned, the claim that Bitcoin is "digital gold" is obviously untenable.

2. Can cryptocurrency be decentralized?

During the Russia-Ukraine conflict, at the request of the U.S. Treasury Department, Binance stated that it would no longer accept transactions initiated by Mastercard and Visa cards issued in Russia. Coinbase stated that it had blocked more than 25,000 addresses related to Russian individuals or entities. USDC issuer Circle also announced that it would temporarily ban all fiat currency payments from Russian accounts.

The root cause of the centralized cryptocurrency exchanges being controlled by sovereign states is the non-digitalization of legal tender. At present, all that can be circulated on the blockchain is digital content, including cryptocurrencies. However, legal tender at this stage has not been digitized, and its circulation with cryptocurrencies still depends on centralized exchanges. Without legal tender, cryptocurrencies are tantamount to being separated from the mainstream financial market, and they will not be able to circulate widely. And going mainstream means that they cannot remain immune to political conflicts.

In the transaction between cryptocurrencies, there are currently two models: centralized exchanges and decentralized exchanges. The trading volume of decentralized exchanges, also known as DEX, continues to rise and will surpass centralized exchanges.

DEX is an important part of decentralized finance DeFi. DeFi is a financial system that can achieve everything from issuing currency, signing contracts to executing transactions through technology and code, rather than through endorsement by "intermediaries".

DeFi seems to be the only way to achieve the decentralization of cryptocurrency, making complete decentralization and anonymity possible. Therefore, the government cannot deploy real-time supervision departments, there are no intermediate nodes to shut down, no companies to subpoena, and even no servers to shut down. Cryptocurrency will truly be free from political control.

But is complete decentralization really good? This means that cryptocurrencies will leave the mainstream market, the government's "visible hand" will not be able to play a role when the automatic adjustment mechanism of the crypto market is unbalanced, illegal activities such as money laundering and dark web transactions will intensify, the underlying blockchain technology and algorithms need to show stronger tolerance and execution accuracy, and when the rights of users are violated, DeFi itself cannot provide guarantees such as recovery and arbitration.

How to choose between decentralization and centralization will be a difficult problem.

Source: 01 Blockchain

3. Cryptocurrency or CBDC?

Today, in order to fight against the hegemony of the US dollar and defend against economic sanctions, countries need to explore ways to avoid cross-border transactions using the US dollar. There are two paths before countries, one leading to cryptocurrency and the other leading to CBDC.

CBDC is a digital currency supported and issued by the central bank. Unlike the "decentralized" characteristics of cryptocurrencies, CBDC is led by the government and can ensure the legal and compliant circulation of funds. The introduction of CBDC is of great significance in the process of economic globalization, including improving the cross-border payment system and strengthening the international competitiveness of the local currency.

Previously, the Atlantic Council's Geo-Economics Center launched a central bank digital currency (CBDC) tracker analysis showing that as of the end of 2021, a total of 87 countries in the world (accounting for more than 90% of global GDP) were exploring CBDC, while this number was only 35 in May 2020.

Amid the current Russia-Ukraine dispute, countries are enthusiastic about building CBDCs. On March 10, Biden signed an executive order on digital assets, emphasizing that the current administration will place the most urgency on researching and developing potential U.S. CBDC design and deployment options. In addition, countries including Brazil, the Philippines, Uganda, Canada, South Africa, and Namibia have also accelerated the process of building CBDCs in terms of policies, research and development.

On the other hand, there are also calls for choosing cryptocurrency as a solution, especially for countries with weak economic strength and facing war. We can see this phenomenon from Turkey, Israel and Ukraine's "favor" for Bitcoin during the crisis. In addition, some major countries have also accelerated the legalization of cryptocurrency after this international conflict.

The Thai cabinet approved the relaxation of rules on digital asset taxation, including cryptocurrencies authorized by the Ministry of Finance; a Republican senator from Wyoming, U.S., said that the bill to incorporate digital assets into the financial system is "almost ready"; John Glen, economic secretary of the UK Treasury, said that the British government confirmed that stablecoins used as a means of payment will be included in the scope of payment supervision, creating conditions for stablecoin issuers and service providers to operate and invest in the UK.