By Kurt Woock
How quickly the fortunes changed for companies that, only months before, seemed to be swimming in success
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In the first half of 2022, the price of every major cryptocurrency dropped. Now, a handful of crypto-related companies are facing serious financial difficulties, including bankruptcy. This period of market cooling has become known as "crypto winter."
Unlike terms such as "market correction" or "bear market," crypto winter doesn't have a precise definition.
"Generally speaking, it's a period of sustained lower prices," says Rayhaneh Sharif-Askary, head of investor relations at Grayscale Investments, an asset management company specializing in digital currencies.
Wherever the threshold lies, it's clear we've passed it. Here's why:
This crypto winter is different than the previous one
The last crypto winter occurred in 2018, when the price of Bitcoin dropped by more than 50% from its all-time high in the middle of a bull market in traditional finance.
The difference between then and now? "This is the first time we're actually seeing crypto trading lower [than before] in a traditional bear market," says Joel Kruger, a market strategist at LMAX Group, which specializes in cryptocurrency services for institutional investors. The bear market could make a crypto recovery more challenging.
"As [crypto] has gotten larger, there's been more sensitivity to the intersection with the traditional finance market and fundamentals," Kruger says.
Read: When will crypto winter end? Bitcoin halvings may not be enough to explain market cycles
The current downturn in crypto prices is part of a global sell-off of nearly all asset classes, rather than something specific to crypto. However, there are a few instances of crypto-specific issues, such as the collapse of the algorithmic stablecoin TerraUSD (known by the ticker UST ) and its sister coin that backed it, called Terra (known by the ticker LUNA ). Because Terra sounds so similar to TerraUSD, we'll refer to Terra as LUNA in the story. (Note: TerraUSD and LUNA have since been rebranded as TerraClassicUSD and Terra Classic, respectively. Thankfully, these new-but-similar names don't come up in this story.)
The collapse of TerraUSD and LUNA
The collapse of TerraUSD and LUNA resulted in $40 billion in investor losses and has had domino effects throughout the crypto industry.
The two coins are linked: TerraUSD is a so-called algorithmic stablecoin that promised stability with a reliable price of $1. And LUNA, its companion coin, was expected to act like a more traditional cryptocurrency with the potential for big price increases.
An algorithmic stablecoin fuses economics and technology to purportedly provide stability to an asset class otherwise known for high volatility. In theory, LUNA's 1:1 convertibility with TerraUSD, along with TerraUSD's redemption value pegged at $1, meant that TerraUSD's price would remain steady. It would be a safe haven for crypto investors much like cash is a safe haven for traditional investors.
In May, this project unraveled. LUNA was worth $116 in April. Since May, the price has hovered around $0.0001. In a July speech at the Bank of England Conference, Federal Reserve Vice Chair Lael Brainard compared it to a classic bank run. The quick demise of LUNA shook individual investors as well as companies with business models that relied on this project to deliver on its promise.
Learn more: Why is UST, LUNA crashing? Collapse of a once $40 billion cryptocurrency, explained
Frozen customer accounts and sudden bankruptcies
While the tech underlying crypto is new, the financial dilemma some crypto companies have recently faced is timeless: If you borrow large amounts of money to make investment bets that don't pan out, you're going to have trouble repaying that original loan.
"Specifically, where we saw the failures were in organizations that focused on centralized lending," Sharif-Askary says. "So, like in any market, you had leverage exacerbating market swings." Or, as Warren Buffet famously wrote, "You only find out who is swimming naked when the tide goes out."
The stories below highlight how quickly the fortunes changed for companies that, only months before, were seemingly swimming in success.
Kruger says the problems facing these companies "are management issues, not representative of the asset class. These are people that are trying to take advantage of a market that's doing well and are overexposed."
But these events do bring into relief the fact that some consumer safeguards found in traditional financial products -- such as FDIC insurance, which protects savers in the event their bank goes under -- are absent in crypto.
Read more:After Tesla sold most of its bitcoin, Elon Musk says he is open to buying more, though 'cryptocurrency is a side show'
What does the future hold?
One popular maxim states that drawdowns happen about every four years. For some, that regularity is cause for optimism.
"I think a lot of investors we're talking to see this as an opportunity," Sharif-Askary says. "It's a reminder that leverage in a system can exacerbate losses. It reinforces the importance of diversification."
The shock of the initial price drops might have worn off, but winter has not yet thawed into spring. Sharif-Askary points to a Grayscale white paper released in July that states Bitcoin, a proxy for the crypto market, could "see another five to six months of downward or sideways price movement."
Check out theCrypto Tracker on MarketWatch
In the meantime, news about some firms freezing customer accounts is a good reminder to do your due diligence when selecting companies to work with, says Kruger, rather than a reason to write off the sector altogether. If you see promises of extremely high yields, he says, "An alarm bell should be going off in your gut."
Disclosure: The author and editor held no positions in the aforementioned investments at the original time of publication.
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Kurt Woock writes for NerdWallet. Email: firstname.lastname@example.org.
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