While the global economy is in crisis, the crypto ecosystem is feeling the full impact of a capital flight. Let’s take a look at this situation, which combines rampant inflation and a drop in cryptocurrency prices that is having an impact on industry players
A particularly tense macroeconomic context
It has not escaped anyone’s attention that the crypto market is in crisis. While the total capitalisation of crypto-currencies has been divided by three, in the space of a year, the macroeconomic situation seems to do nothing to help.
Firstly, the war in Ukraine continues and the situation threatens to become worse than it already is at any time. The health crisis, which has not been fully resolved, is also a concern.
On the other hand, the various central banks are struggling to contain runaway inflation, which is keeping the financial markets under pressure.
Although a slight drop in inflation was expected, the figures published last Friday swept away this hope. The consumer price index reached 8.6% in May in the US and 8.1% in Europe.
These figures are weighing on risk assets. The S&P 500, the US market’s benchmark index, has already lost more than 22% since its all-time highs in January.
Figure 1: S&P 500 mini future contract price
Financial analyst Vincent Ganne, who speaks weekly on our YouTube channel as well as Monday to Friday on the Grille-Pain, our private Discord group, commented on this situation in his latest video:
“So it’s an asset class, which no longer benefits from what used to be called TINA, There is no alternative. In the days when money was free, when rates were low […]. Now interest rates are going up vertically. […] Inflation is out of control, in the US, in Europe, at 8%. The market had hope, because for a month inflation had slowed in the US and last Friday that hope was shattered. “
How did we get here?
It’s not new for central banks to support growth with low interest rates. But the phenomenon took on a disproportionate scale after the subprime crisis in 2008. Policymakers had a choice between letting the problem settle naturally, at the risk of bankrupting countries and companies, or resorting to money printing.
The latter option was chosen, leading to negative interest rates and feeding the financial markets with artificially created money for years.
Some organisations then literally made money by borrowing. Because they paid back less than they borrowed. This money was reinvested, and in a bid to diversify, institutional investors turned in part to the cryptocurrency market, which therefore also benefited from this money creation.
This process is fuelling inflation, but at a level that was previously relatively acceptable. However, the health crisis and the war in Ukraine are two triggers that have put many industries under pressure. The various shortages have allowed inflation to soar even higher, highlighting the flaws in the monetary policies pursued so far.
Central banks are now reversing course and raising rates to counter this inflation. Now that the tap of free money is closing, risk aversion is back among institutional investors.
Cryptos being a particularly risky sector, it is consequently one of the first to be abandoned by these investors. Finding themselves at the bottom of the ladder, prices then fall by communicating effect.
This Wednesday 15 June, the market is expecting a third consecutive rate hike. It will then be interesting to observe the reaction of prices. So, as long as inflation is not countered and the geopolitical situation remains tense, prices will not be able to recover sustainably.
The crypto market faces this crisis
Since the highs of last November, the price of Bitcoin (BTC) has lost nearly 70% of its value.
Figure 2 – BTC price in weekly chart
The king of cryptocurrencies is thus more or less defending the prices that had acted as highs in 2018. This had resulted in an 85% drop to $3,000.
Although the Terra (LUNA) episode in May did not help the situation, the chart in Figure 2 shows that prices did not wait for this to start deteriorating. Instead, cryptocurrencies are suffering from an exacerbated positive correlation to the equity market.
While Wall Street had come to support this latest bull run in the crypto ecosystem with its liquidity, the current crisis is generating a massive withdrawal of capital.
Altcoins are paying an even higher price, with devaluations sometimes hovering around 90% since the previous All Time High (ATH) as shown in the top 10 illustration below:
Figure 3: Percentage drop in cryptocurrencies since their respective ATH
The impact of the crisis on the crypto ecosystem
While digital assets may qualify as a bulwark against inflation in the long term, the short-term tremors make it clear that the category does not yet have safe haven status. This capital flight is not without consequences for the ecosystem.
The first visible repercussion of the bear market, beyond prices, concerns redundancies. We regularly give examples and will come back to them in more detail shortly. But there are more insidious dangers lurking for some players.
The tweet below mentions the BTC reserves of El Salvador, Microstrategy, Tesla and Block:
El Salvador, Microstrategy, Tesla and Block holdings pic.twitter.com/SAAGZqxR3C
– db (@tier10k) June 13, 2022
All of them are losing money. From just 8% for Block to over 44% for El Salvador.
However, El Salvador does not seem to be officially concerned. Alejandro Zelaya, the country’s finance minister, said that Bitcoin accounts for only 0.5% of El Salvador’s national budget and commented on the situation in a reassuring tone:
“When they tell me that the budget risk of Bitcoin for El Salvador is high, the only thing I can do is smile. “
On the other hand, if the price of BTC were to settle permanently below $21,000, then MicroStrategy would face a margin call on its collateralised bitcoin loan. With a loan of $205 million, this implies at least twice the collateral. However, the price of Bitcoin has now halved since this operation, mechanically lowering this collateral proportionally.
The company will therefore have to either reinforce this guarantee or sell part of its position. The latter solution would undeniably accentuate the fall. But it’s the first option that CEO Michael Saylor wants to pursue with 115,109 BTC ready to come in as reinforcements:
MicroStrategy has a $205M term loan and needs to maintain $410M as collateral. $MSTR has 115,109 BTC that it can pledge. If the price of BTC falls below $3,562 the company could post some other collateral. See slides 11-12 in Q1 2022 presentation. HODLhttps://t.co/9WHsIB6Usx
– Michael Saylor⚡️ (@saylor) May 10, 2022
Finally, another point of tension concerns the centralised platforms offering yield, of which Celsius is a telling example. The latter has suspended withdrawals to cope with the outflow of cash from many users. Indeed, this trend is causing friction because funds are sometimes locked up, making it impossible to fully honour investors’ payments.
Celsius has reportedly sent several tens to hundreds of millions of dollars of ETH and BTC to FTX, to free up liquidity and allow payments from its users:
PeckShieldAlert Celsius transferred ～3,500 $WBTC (~$89m) to FTX within the last hour. https://t.co/nKCorHfuex pic.twitter.com/juiz6NmOpN
– PeckShieldAlert (@PeckShieldAlert) June 13, 2022
In view of all these elements, if we cannot deny that the crisis situation is critical, let’s remember that the crypto ecosystem is here to stay. This is evidenced by the investment companies that are preparing for the future, such as a16z and its recent $4.5 billion fund to develop Web3 projects.
While it is important to remain cautious, responsible and methodical in the face of this situation, it is important to remember that the best deals are usually made in times of uncertainty. However, one should not rush into the market, bearing in mind that while this may be a good entry point, it may not be the end of the downturn.
