Almost all markets present behavior patterns - from stocks to commodities and everything in between - and crypto is not different. These patterns are driven by supply, demand, news, and human emotions. While over short periods of time, this behavior may seem unpredictable, in the long run, patterns start to emerge.
From a broad perspective, it behaves as follows: while the market (people) is optimistic about a particular asset class, the demand for them is driven by early investors. With the price going up, other groups start to invest and FOMO (Fear of Missing Out) takes place, raising prices even further. When there is the perception that prices will not grow, especially among the early investors, a shift starts to occur, but the selling pressure is not yet greater than the buying pressure, which creates volatility. Finally, driven by fear, in some cases due to external factors such as news, regulations, or unexpected events, the selling pressure wins and prices start to fall, and the “winter” arrives.
The recent crypto winter probably started to take shape in November 2021, when the capital markets began to feel the effects of the increase in US interest rates. On top of that, a weakened macroeconomy due to Covid, the start of the war in Ukraine, high inflation rates (the highest in 40 years in the United States), and signs of an economic recession all but confirmed that a bear market was approaching. Then, in May 2022, the depegging of the Terra/LUNA stablecoin took the market into a downward spiral. Retail, institutional, and even corporate investors lost over US$ 60 billion in LUNA, as one of the largest tokens in market cap evaporated in a matter of days.
The crash of both coins was the final blow that led the hedge fund Three Arrows Capital (“3AC”) – which managed nearly US$ 20 Billion in digital assets – into bankruptcy, since it had high exposure to the token. As the price of LUNA crashed, 3AC was forced to liquidate its positions due to unmet margin calls on leveraged positions. This move bankrupted the fund, taking with it Voyager and Celsius, two other institutions which were 3AC's creditors. Together, Voyager and Celsius lent nearly US$ 770 Million to the hedge fund – 3AC owes about US$ 3.5 Billion to 27 companies in total.
In short, Three Arrows Capital's high leverage, coupled with inappropriate risk management, caused these funds to turn to dust and the prices of major cryptocurrencies plummeted as a result, causing Bitcoin to crash through the US$ 20k barrier and to remain below it for a while.
In November 2022, yet another event occurred, this time involving FTX and Alameda Research, which led to another crash in crypto prices. For context, FTX was second in the rank of centralized exchanges, and Alameda Research, a quantitative cryptocurrency research institution. Both companies were founded by the same entrepreneur, Sam Bankman-Fried, also known as SBF.
The crisis started when Coindesk released an article revealing that Alameda had held about US$ 5.5 Billion worth of FTT (FTX’s token) in collateral and debt leverages. However, The liquid market cap of FTT tokens was about US$ 3.35 Billion. In other words, Alameda couldn’t sell its FTTs - which represented around 41% of its balance sheet - without crashing the market.
Things escalated after Changpeng Zhao (CZ), founder and CEO of Binance, announced that he intended to liquidate US$ 2 Billion worth of FTT that Binance had received after selling back FTX shares - Binance was an early investor and strategic partner of the emerging exchange. This event generated panic in the market and a snowball effect was created when FTX clients started to withdraw their assets. This led to freezing withdrawals and, ultimately, resulted in FTX’s bankruptcy (and that of another 100 companies of the group, Alameda Research included).
All the mentioned events resulted in the fall of the crypto market cap (bitcoin hit less than US$ 16k) and many other companies that had resources in FTX or high exposure to FTT started releasing notes about huge losses and bankruptcy, such as the cryptocurrency lenders BlockFi and Genesis.
But this wasn't the first event of its kind, and it won't be the last time the market deals with a crypto winter. In 2018 we saw a similar crash in value, though within a different context.
In this context, the year of 2017 was an especially promising one for cryptocurrency startups, which attracted a record amount of capital, most of it from retail investors. There was a burst of ICOs and the total market cap of the crypto industry hit its all-time high at US$ 800 Billion. Too much “dumb” money followed all these new projects and 90% of them failed just six months after launch due to lack of fundamentals and solid execution. Adding to that, the rumors that Asian countries were planning to ban cryptocurrency trading, and the hack of the main Japanese exchange, Coincheck, in which US$ 530 Million was stolen from the platform, contributed to the crash, with prices falling more than 50% at the time.
Since the beginning of 2023, Crypto prices have been on the rise. In one week (01/01 - 17/01) $BTC rose up by 27,8%, $ETH 31%, $SOL 129,7%, and the Crypto Market cap almost hit US$ 1 Trillion.
There are some possible explanations for this. US Inflation continues to fall, and the last CPI report was at 6.5%, a 6th consecutive monthly decrease.
Furthermore, in the same period, the short position liquidations reached the highest level since July 2021, from January 11 to 14 over US$ 916 million were liquidated, which may have influenced the prices positively.
Looking at the RSI (Relative Strength Index) - used in technical analysis to identify if an asset is overvalued or undervalued according to its average gains and losses in a determined period of time - the current $BTC RSI is around 90, and historically it means that a price correction is near.
We believe that the macroeconomic scenario didn't change enough to justify the start of a bull run. EU inflation and US interest rates are expected to continue to grow. And there are many factors that might add uncertainty to the system, such as the progress in crypto regulation, FTX’s bankruptcy effects, and the conclusion of the XRP Lawsuit is approaching. If the CEC argument wins, XRP will be classified as a security, endangering similar assets, but on the other hand, if Ripple wins, it may positively affect the crypto market.
Another aspect to take into consideration is that given the current uncertainty, institutional investors are not keen to allocate capital in the Crypto market. Usually, there is no bull market if those players are not at the party. Furthermore, Venture Capital funds had a major role in the past bull run. With high liquidity, there was a surge in the number of VC deals and valuations in 2021 and in the 2022 first quarter. However, with higher interest rates, VCs are more cautious. This led to a plummeting trend in the number of deals and investment volumes, especially in crypto (high risk assets), that shows no signs of reversion in the short term.
So, since VCs capital - and other institutional investors - is no longer o the table, it’s highly unlikely that prices will raise back to 2021 levels.
In this context, we believe that the current market trend is momentary since prices might still fluctuate with a downward trend in the near future. We believe that in order for the next bull run to take place, more significant technology development and changes in the macroeconomic scenario should happen.
If you like this content, you can find a deeper discussion about the state of crypto on our Crypto Paper, or if you are an entrepreneur with a Web3 product, contact us, we are investing!
DISCLAIMER: This material is provided to you for informational purposes only. This is neither an offer to sell nor a solicitation of any offer to buy any securities in any fund managed by Iporanga Ventures (the “company”), nor is it an offer to provide investment advisory services. And the targeted performance contained herein is provided for illustrative purposes only and is not intended to serve as, and must not be relied upon by any person as, a guaranty, an assurance, a prediction of a definitive statement of fact, a probability or as investment advice.