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14-05-2022|Crypto

Why is crypto going down? A Q&A on bitcoin, luna and other falling cryptocurrencies.

The cryptocurrency market is seeing one of its worst selloffs since a market boom in 2020, causing investors to fear and raising questions about why cryptocurrency values have become increasingly sensitive to stock market gyrations.

In particular, stablecoins are growing rapidly. Because the tokens are tied to the value of a currency such as the US dollar or a commodity such as gold, that sort of cryptocurrency is expected to have a stable value, as the name implies. This provides considerable protection from excessive volatility.

Stablecoins have also crashed. What's the story here? What does the crypto market have in store? For a wide overview, we spoke with finance and investment specialists.

What is causing bitcoin and other cryptocurrencies to plummet?


The recent downturn in the cryptocurrency market, according to industry experts, is being driven by two primary factors: measures by the US Federal Reserve to combat rising inflation and stabilise markets, and the implosion of terraUSD, a sort of so-called stablecoin.

1. Macroeconomics: Let's start with macroeconomics to understand the first factor. To combat the pandemic-driven economic slowdown, the Fed slashed interest rates, or the cost of borrowing, in early 2020, essentially injecting more money into people and businesses.

The end result was inflation reaching its greatest level in four decades. As traders spent their money in anticipation of higher returns, prices rose across most asset classes, including traditional stock markets and cryptocurrency markets.

Rising prices cause people economic suffering since our earnings aren't rising in lockstep with prices, and they hinder economic growth more widely. To mitigate the damage, the Fed boosted interest rates by half a percentage point earlier this month, the highest increase in nearly two decades. The Fed is also decreasing the money supply to further reduce inflationary pressures, and it is expected to keep raising rates in the future.

All of this causes concern among investors. Since the start of the year, the S&P 500 and Nasdaq stock indices have lost more than 20% of their value. Meanwhile, according to statistics compiled by CoinGecko, which examines the digital currency market, the market valuation of the cryptocurrency market has more than half from its peak of about $3 trillion in November to $1.3 trillion presently.

The price of bitcoin fell below $30,000 for the first time since July earlier this week. Bitcoin is the most widely traded cryptocurrency in the world, accounting for more than 40% of the market.

2. TerraUSD: What has attracted the attention of crypto watchers recently is terraUSD, often known as UST, and its impact on its sister cryptocurrency, luna.

The Terra network, a blockchain project based in South Korea, has generated two cryptocurrencies. UST uses Luna as a collateral currency.

What is the difference between luna and UST cryptos?


Stablecoins, such as terraUSD and luna, were promoted as a type of crypto asset that provided better stability during market turbulence, as the name suggests.

The value of the UST token is tied to the US dollar, which implies that one UST should always be worth $1. If the coin's value falls below a dollar, it can be "burned" and traded for a dollar of luna.

Luna began trading in May 2019 at around $3 and reached an all-time high of around $116 in April, according to CoinGecko data, during a period when most other large-cap cryptocurrencies were plummeting.

UST broke its peg to the dollar earlier this week, and for the first time, the value of one UST went below a dollar — to less than 30 cents.

What became of Luna? What's the big deal about that?


Large luna holders cashed out as the price of UST fell, causing the supply of luna tokens to increase and the price to fall. On Thursday, Luna lost 99 percent of its worth.

According to Bloomberg Intelligence, luna's dramatic value decrease appeared to be the worst day for a financial instrument ever witnessed, prompting cryptocurrency exchanges to delist the coin, halting trading due to a lack of liquidity.

The unique price structure of the UST token could be one cause for the severity of the drop, according to Edward Moya, a senior market analyst at OANDA, a foreign exchange platform.

Other stablecoins, such as tether, are backed by a government-backed currency or commercial papers, however the UST is not. It's an algorithm-based stablecoin that uses a sophisticated approach to ensure its value against the dollar with the help of luna.

"Most stablecoins will require actual assets to work, but UST's algorithmic solution was unable to handle the current market volatility in the bond markets." "As a result, there was widespread panic selling," Moya explained.

While the price of terraUSD fell to as low as 30 cents, the price of luna plummeted to $0.00001655, down from over $81 earlier this week. On Thursday evening, Terraform Labs announced that it had suspended the blockchain that underpins cryptocurrencies and will "come up with a plan to rebuild it."

In its biannual financial stability report, the Fed expressed concern about stablecoins, stating that the fast developing sector, which accounts for around 15% of global cryptocurrency market capitalization, is prone to runs and that its risks could spill over into traditional markets.

Is the cryptocurrency market now more similar to the stock market?


For months, the cryptocurrency market, like the stock market, has been declining. It peaked in November, and since then, all asset markets have experienced a correction as a result of the Fed's strong liquidity tightening measures.

Market experts note that the correlation between traditional markets and the cryptocurrency market is at an all-time high: if one falls, the other will almost certainly follow, or vice versa.

Defiance ETFs' chief executive and chief investment officer, Sylvia Jablonski, said the correlation with the Nasdaq is at 0.82, up from below 0.5 in the past (on a scale of 0 to 1). In similar terms, both traditional and stock markets are moving in comparable directions now more than ever, indicating that investor sentiment is spilling over.

Experts have noticed a greater link between cryptocurrencies and tech companies, which were among the worst-affected stocks during the current market downturn.

I thought crypto was an inflation hedge?


Some cryptocurrencies, particularly the market leader bitcoin, were promoted as assets whose value would hold over time, making them an excellent inflation hedge.

However, as inflation has risen, bitcoin's price has more than halved, making it less appealing to investors during periods of high costs.

Caleb Franzen, a senior market analyst at Cubic Analytics, a big data analytics firm, believes bitcoin will continue to operate as an inflationary hedge in the future. According to some models, bitcoin's value could fall to $19,000 to $21,000 in the immediate future, but it could prove to be an useful hedge over the next five to ten years.

What happens after that?


Is crypto about to see a Lehman moment? (Lehman Bros. was a major investment bank that failed in 2008 and played a role in the financial crisis.)

"Not yet. "You can never say never in cryptocurrencies," said OANDA's Moya. "While possible catalysts exist, there does not appear to be a systematic risk."

Franzen believes that a significant increase in the value of bitcoin could signal an increase in inflation, similar to what occurred between March 2020 and November 2021.

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