The Macroeconomic Crypto Climate, Explained

AccessTimeIconJan 10, 2023 at 3:27 p.m. UTC
Updated Jun 8, 2023 at 9:39 p.m. UTC
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Over the summer, Three Arrows Capital, Celsius Network and Voyager Digital failed shortly after the collapse of UST, the stablecoin project led by Do Kwon, who promised that a token called LUNA would help its stablecoin, worth tens of billions of dollars at the time, maintain parity with the U.S. dollar. The whole thing unraveled when investors lost confidence in the mechanism, bringing financial ruin to companies exposed to the coin. Then, as the crypto winter set in, another set of companies, among them CoinDesk sister company Genesis and BlockFi, went into crisis mode after the behemothic crypto exchange FTX filed for bankruptcy protection after a CoinDesk article exposed a huge hole in FTX’s finances.

The cascading collapses were spurred on by a tough macroeconomic climate. The founder of stablecoin FRAX, for instance, pins the collapse of UST to the U.S. Federal Reserve’s interest rate hikes. “The real reason this is happening is more of a dollar liquidity crisis and dollar purchasing power rising against all assets,” he told crypto publication The Defiant in May. “When Fed rates rise, liquidity … gets sucked out [of everything and put] into U.S. Treasurys as the risk-free rate rises.”

The macro-economy works in cycles of boom and bust, and it’s pretty clear that the world is in the latter right now. In the boom times, interest rates are low, providing cheap cash to startups that want to raise money. Only last year the venture capital market was “just insane,” Waltter Kulvik, a partner at U.K. law firm Eversheds Sutherland, told Fortune. It was easy to score investments for anything related to crypto because the money was so easy to come by and loans were cheap. Crypto merger and acquisition deal activity in 2021 hit $9.9 billion, the highest on record, and VCs invested $32.8 billion.

All that happened around the time of the COVID-19 pandemic, when central banks worldwide pumped money into the economy like never before. They did so in an attempt to offset the stagnation caused by the coronavirus, which kept everyone inside their homes and away from factories, shops and office desks. In crypto, that coincided with an all-time high for bitcoin, as well as the launch of some highly speculative non-fungible token (NFT) and decentralized finance (DeFi) projects.

But prices can’t go up and to the right forever, and the debt began to accrue. Consider how the largest bitcoin miner in North America, Core Scientific, took on a debt-to-equity ratio of 0.58 in April 2022 – a particularly high value given that, as Jaran Mellerud of Hashrate Index wrote, “Bitcoin mining is an exceptionally volatile industry with deep bear cycles that can last very long.”

At the same time, inflation began to rise, and central banks started to hike interest rates – once close to zero – right back up to pre-pandemic levels to prevent their currencies from devaluing due to all the money they had printed. That made loans expensive, preventing crypto companies from continuing to use cheap money to prop up their operations.

When central banks pushed hard on the brakes, a lot of money came out of risky investments and back into safer ones. As investors withdrew their risk, pandemic stocks such as Peloton crashed, as did the “meme” stocks that furnished the height of the 2021 bull markets, including GameStop and AMC. No wonder, then, that plenty of crypto companies defaulted.

Then, in 2022, tech companies – most of them little more than speculative bets on other transformative technologies, started to lay off their staff as stock prices fell. Facebook, which rebranded in late 2021 to Meta Platforms at the height of the metaverse craze, laid off 11,000 of its staff in November 2022, or 13% of its workforce. So did crypto companies, which became leaner operations after growing too quickly.

And so, now the economy lies in its latest downtown. It’s not just the U.S.; China is going through its own days of reckoning after its housing market overheated. These cycles of boom and bust are commonplace in the financial markets, and are a feature of any capitalist system.

This cycle happened last in 2008, when bull market excess triggered a banking collapse in the U.S. financial system. Back then, venture capital fund Sequoia Capital declared “RIP Good Times,” and had to wait several years for the next market upswing. And before then, 2001, and so on and so on. The National Bureau of Economic Research found 34 economic cycles between 1854 and 2020, with each rotation taking an average of 4.6 years.

Ray Dalio, of Bridgewater Associates, said in “The Changing World Order: Why Nations Succeed and Fail” that nation-states have their own boom and busts, and that those cycles can take hundreds of years. Put that way, crypto’s craziness last year, and its destruction this year, is just a footnote in the latest edition of bull market excess.

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Robert Stevens

Robert Stevens is a freelance journalist whose work has appeared in The Guardian, the Associated Press, the New York Times and Decrypt.

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