Why have crypto markets collapsed?

The latest downtrend of cryptocurrencies has seen the market crater over the past few months, with individual digital tokens dropping to their lowest marks in two years and the overall sector having plummeted by nearly $2 trillion in value since late last year. 

The price of Bitcoin (BTC), the most popular cryptocurrency, dipped under $18,000 on Saturday before rebounding back over the $20,000 level. The last time Bitcoin was at that level was in November 2020, before it was on its way to an all-time high of nearly $69,000 last November. 

Bitcoin has lost more than 70 percent of its value since. Other major tokens like Ethereum and altcoins have endured a similar fate.

With investors selling off in a panic as turmoil in the crypto market ensues, firms are forced to slash payrolls.

So what exactly is driving the recent decline of cryptocurrency values?

From bull to bear

The foundation for a bull run in the crypto market was laid in March 2020, when the World Health Organization (WHO) declared Covid-19 as a pandemic that stalled social and economic life due to lockdown restrictions imposed by nation states across the globe.

Since then, “many states gave incentives to support the economy [and] international companies made large BTC purchases,” Helin Celik, crypto market and blockchain analyst based in Istanbul, told TRT World.

Underlining more than 225,000 Bitcoin currently held by 27 public companies, including Tesla and MicroStrategy Inc, Celik said that corporate purchases increased during the pandemic.

“While these purchases triggered the upward movement in the market, individual purchases followed the corporates,” Celik said.

Under these circumstances, the major cryptocurrency’s value started rallying and reached a peak of $69,000. As the liquidity of the cryptocurrency market increased, it reached a volume of $3 trillion by the end of 2021.

After vaccines helped battle the pandemic and lockdown periods for the world economy ended in 2021, consumption-based inflation started to appear. “Especially in the US, unemployment increased, growth forecasts were lowered and inflation started to create a stalemate on a global scale,” Celik said.

In order to stop inflation, countries started to increase interest rates. Last week, the US Federal Reserve raised its benchmark interest rate by 75 basis points, marking its biggest rate hike in 28 years. 

While a ton of money flowed into crypto investments throughout the pandemic, rising interest rates forced investors to move their money away from high risk assets like crypto. 

The conflict between Russia and Ukraine also caused chaos in the market, as disruptions in the supply chain and increased energy prices further exacerbated inflation.

Terra’s collapse

One of the triggers for the contagion in the crypto market were stablecoins, or cryptocurrencies that are supposed to protect buyers from the volatility of digital currencies by pegging their value to a reserve asset like the US dollar.

In May, the Terra ecosystem crashed as hundreds of billions of dollars were wiped off from the market. TerraUSD (UST) stablecoin and its sister token Luna, dropped to almost zero from a combined value of more than $40 billion just before their fall, causing massive selloffs.

“The devaluation of Terra's stablecoin and the foundation's core coin LUNA is the first internal dynamic to trigger panic selling,” Celik said. 

“The systematic problems in the crypto market damaged the confidence of the investor and accelerated their exit from the market. At this point, too many long positions were liquidated, except for the funds shifted to different financial instruments,” she added.

“While the market was falling, miners started to sell coins to the cryptocoin markets with the increasing energy costs and the decrease in profit.”

While long-term Bitcoin investors and miners were selling, BTC reserves began to increase, Celik said. 

“With the deterioration of demand-reserve balance of Bitcoin, the price continued its plunge.”

Celsius’ freeze

Just weeks after the collapse of TerraUSD, came another domino that shook the market.

Last week, major US crypto lending company Celsius Network froze withdrawals and transfers citing "extreme" market conditions.

Celsius says on its website that customers who transfer their crypto to its platform can earn an annual return of up to 18.6 percent. The website urges customers to "Earn high. Borrow low".

In a blog post, the company said it had frozen withdrawals, as well as transfers between accounts, "to stabilise liquidity and operations while we take steps to preserve and protect assets."

After Celcius froze user accounts, “a large amount of BTC and ETH outflows were observed from the wallets,” Celik said.

“The Celsius institution, which could not make the payments of its customers, also invested in TerraUSD's Anchor and lost approximately 55 million dollars from it,” she added.

Although rescue plans are currently underway for Celsius, Celik suggested investors to pay attention to the process.

As the market downturn continues, crypto firms like Coinbase have made drastic cuts to their workforce, and are adjusting for what many believe will be a protracted lull for digital tokens.