If you are a crypto investor, you’re probably worried about the future of your investment following the events that have been unfolding for a few weeks. As the cryptocurrency market capital keeps plummeting to new lows, some even compare this crypto market trouble to the Lehman Brothers crash of 2008.
The crypto market is worryingly down, the market cap is less than half of what it used to be when it was at its peak. And worse, the failure of Terra has wiped out over forty billion dollars of investors’ money from existence. From the surface, it looks like a scary time for crypto. But how terrifying is it for investors?
As some experts are justifying their previous warnings about the pitfalls of investing in cryptocurrency and some envision this situation as a great opportunity for investors, we would like to dig deeper and investigate what we can learn from this turbulent time for the crypto industry.
In this article, we discuss the recent trouble in the crypto industry, how it came to existence and what are the biggest takeaways. Plus, we discuss possible opportunities that you might probably not yet be aware of.
What actually happened
It all started when a Stablecoin called Terra began a free-fall on the first weekend of May 2022. As a result, the whole crypto market suffered a nasty blow. With its value tanking beyond belief, once one of the top 10 crypto coins is now virtually worthless as of the 28th of May 2022. Just at the beginning of the month, its market cap was over US$18.7 billion. Now, it’s barely a billion.
The crash of Terra caused a domino effect on the whole crypto market. As a result, most cryptocurrencies drastically lost their values within days. The biggest cryptocurrency, Bitcoin has lost more than 62% of its value from its all-time highest worth back in November 2021. Other cryptocurrencies, including Ethereum, Tether, Solana, and Dogecoin have a similar story.
As of the final week of May 2022, the market cap of cryptocurrency has dropped to $1.3 Trillion from a little above $3 Trillion at its peak in November 2021. Some losses seem beyond repair.
Why is cryptocurrency going down
To understand the reason behind the crash of the entire crypto market, we first need to understand Terra (Terraform Labs) and its network token, Luna. These are the cryptocurrencies that had grown excitingly when the entire cryptocurrency market was slowing down. The coins were attracting more investment, primarily because the promised return was exciting. Unsurprisingly, a lending platform called Anchor was behind this too-good-to-be-true annual percentage yield of 19.5%.
Anchor’s promise was so attractive that people began investing in Terra and depositing it on Anchor protocol. As a result, more than 70% of Terra’s circulation was deposited on the protocol. It blew up the coin’s value even when other coins were doing not so good.
Moreover, the whole system was supported by a $3.1 billion foundation called Luna foundation guard. Established to support the stability of Terra Stablecoin, the foundation was the second-largest known holder of Bitcoin. The purpose of the reserve was to hold market confidence in Terra if any event leads to a price shift.
What could possibly go wrong?
Everything was great from a perfect world perspective, but Anchor couldn’t keep its promise as its revenue dwindled. As the revenue shrunk, Anchor reduced its interest rate to 4% per annum from 19.5%, causing investors to withdraw their Terra coins out of panic. The mass withdrawal and the sale of Terra and Luna in huge numbers caused the market to lose confidence in the algorithms, causing the value to go down to almost nothing.
Things became worse when Luna Foundation Guard sold a massive amount of Bitcoin to balance the equation of the Stablecoin. As the foundation began selling Bitcoin to buy Terra and support its plummeting value, it caused the devaluation of Bitcoin and ultimately, the entire crypto market.
Why Cryptocurrency price changes
A tweet from Elon Musk or a mention from a leading media company in one of its featured stories can affect the value of Cryptocurrency. Looking at the recent fluctuation in the price of cryptocurrency, you must be thinking anything can make cryptocurrency price change. Well, you’re not entirely wrong.
The value of Cryptocurrency is extremely volatile. A five or even ten per cent instant fluctuation in price is not surprising in the crypto world. Moreover, the fact that cryptocurrency is not backed by a central authority unlike the fiat currency or exchanges, is another reason behind the volatility in its price.
Many direct and indirect factors affect the demand for cryptocurrency, making its price change so rapidly. It could be positive or negative media coverage, the reputation of the cryptocurrency or arbitrage.
How Cryptocurrency price is determined
The value of cryptocurrency is determined by a basic supply and demand factor, like everything else. However, there are a few other elements that also affect cryptocurrency’s value. Some of them are the cost of production, availability, competition, and government rules and regulation.
It’s not very hard to understand the supply of a cryptocurrency as each crypto publishes its token plans. Some have a fixed maximum supply while others have no limitation on their supply. Let’s take Bitcoin and Ethereum, for example. In the case of Bitcoin, we are already well aware that the maximum supply of the coin is 21 million Bitcoins. On the other hand, there can be unlimited Ethereum. Moreover, some cryptocurrencies “burn” tokens to avoid the supply from exploding. Burning is done by sending a token to an unrecoverable address on the blockchain.
The demand for a cryptocurrency generally increases with its awareness and adoption. For instance, the value of Bitcoin increased as investors began buying and holding it. Its value grew more as companies began accepting it as a currency for transactions.
Activities on the blockchain may also be responsible for increasing a cryptocurrency’s demand. For instance, the demand for Ether(ETH) increases as more Defi projects are active on the Ethereum blockchain.
Let’s discuss the other factors that directly or indirectly affect the value of cryptocurrency.
- Production: New crypto tokens are created through code when a process called mining confirms the transaction. The people who invest their time and money in mining coins are called miners. The decentralized network of miners helps cryptocurrency work. In return, the system offers rewards in the form of cryptocurrency tokens for every successful verification, along with regular compensation to the miners. The cost of mining can affect the value of a cryptocurrency. As it increases, the price of crypto also increases since miners won’t mine at a loss. The more competitive and complex the mining is, there is an increased cost with it.
- Availability: There are many cryptocurrency exchanges and platforms that help users buy or sell a cryptocurrency. However, not all cryptocurrencies are listed exclusively on all exchanges. This not only limits the availability of a cryptocurrency but also the ability of users to make a transaction. Popular cryptocurrencies, such as Bitcoin and Ethereum, are available on most exchanges.
- Legal regulations: There’s still confusion about whether cryptocurrencies are securities like stocks or commodities like gold. Therefore, crypto regulations are not clearly defined in most countries, and they keep changing. Any regulation disfavoring crypto transactions can negatively impact the value of a cryptocurrency.
Terra’s value fell to almost nothing because its demand decreased dramatically after Anchor reduced its interest rate to 4%.
Major takeaways from the crash
The failure of Terra is the result of a plan that failed to deliver an over-ambitious promise. It succeeded in attracting investments but failed to provide the promise it offered. As a result, a little turbulence caused people to lose their trust in it. Terra may not have crashed had people not panicked and made a mass withdrawal. However, failure to include how to handle such situations in their plan is the sole reason behind this cryptocurrency’s crash. Some experts argue that Instant availability for withdrawal might be another reason behind Terra’s crash. As an investor, we can learn a few things from this incident:
- Invest only what you can afford to lose
- Understand the volatility of the market before investing in it
- Research well before investing in attractive plans.
What it means to you as a crypto investor
One turbulence doesn’t mean the whole idea of the cryptocurrency has failed. This type of crash happens in every market and has been happening throughout history. As an investor, you should know that there are the best opportunities during the hardest times if you can identify them and act in time. Successful investors from the past have benefited the most when the market suffered.
Take this for an example, last time when Bitcoin’s value was at its all-time high, you regretted not investing in it a year ago when it was $30,000. Now that it’s below $30,000, what’s keeping you from investing in it.
A calculated investment decision is crucial for your financial success. It’s out of the question that the recent cryptocurrency market crash has affected so many investors. However, it has also come with an opportunity. Investing in it when the market value is low can bring you a financial benefit beyond your belief. However, investing only what you can afford to lose remains the best advice for any investment. Otherwise, it could be all gambling.
Michael Ghimire 