Why Investors Need to Welcome the Cryptocurrency Bear Market With Open Arms.
Updated: Feb 1
The Terra (Luna) collapse in May 2022 set the dominoes in motion for the contagion in the cryptocurrency market including the FTX bankruptcy
Market bubbles and crashes such as the crypto market of 2020/2021 are common with every industry or innovative technology such as the dot.com bubble and housing bubble. These are necessary market cycles to strengthen the industry or technology
The thesis is nowhere near dead for cryptocurrency. Investors need to welcome the cryptocurrency bear market and any pain ahead for crypto to succeed in the long term. The bear market or crypto winter will validate the thesis for blockchain technologies
By now, most people are aware of FTX’s bankruptcy--previously the third largest cryptocurrency exchange--and the contagion that followed. The extent of the fraud and misdeeds of FTX’s CEO, Sam Bankman-Fried, will probably not be known until he sits in a courtroom; however, the FTX meltdown has sent tremors throughout the entire cryptocurrency industry. See the link below for the full breakdown of the incident.
The overleveraged and fraudulent bad actors in cryptocurrency prove that crypto may very well solve many problems in the world someday, but it cannot solve human greed.
Nearly every cryptocurrency company such as U.S. digital currency lender, Genesis; crypto exchange, Crypto.com; and digital currency investment services leader, Grayscale, has been brought under closer scrutiny. The contagion has even led some companies such as Blockfi to bankruptcy.
First, it is helpful to understand that the narrative of an investment follows the price; the price does not follow the narrative necessarily.
What this means is that when cryptocurrency prices were at all time highs in November 2021, the narrative followed that the Bitcoin and decentralized financed tokens would spark the metaverse and replace the financial system. Every YouTuber was pushing crypto exchange promotions and spewing one million dollar Bitcoin price forecasts.
Now that cryptocurrency prices are at multi-year lows, the narrative is forming that cryptocurrency is dead and the entire industry is a scam.
There is no sugarcoating the recent fallout: cryptocurrency has been in turmoil, and if things worsen, it will be interesting to see if the technology survives. However, there is still hope.
The thesis for some of the largest cryptocurrencies may not be completely busted. Crypto and blockchain technologies are not dead. The collapse of the Terra (Luna) in May 2022 set the dominoes in motion for the more recent FTX and BlockFi bankruptcies. These calamities definitely slowed down the transition from centralized finance to decentralized finance. However, there is no stopping the replacement of trust from centralized finance with the truth of blockchain and its immutable, public ledgers.
In fact, investors should be cheering on the market downturn and welcome this crypto bear market. It is this temporary cryptocurrency collapse that will ensure that crypto survives this upcoming recession and thrive in the long term. There are ways for long term investors to profit from this fear and uncertainty.
One of the few benefits of this crypto winter is that it weeds out and purges the bad actors in the industry.
The fraudulent or poorly managed cryptocurrencies and blockchain companies such as FTX and Terra(Luna) can operate and exist indefinitely in a bull market as long as new investors’ capital keeps rolling in. As long as a bull market, like the one from 2020-2021, persists, companies and foundations can continue to over-leverage themselves while operating with dishonest, poor business decisions.
Whenever there is an overhyped investment class, like cryptocurrency was a year or two ago, the laws of greed and economic incentives dictate that there will always be fraud and malpractice especially in industries where there is little government or state regulation.
However, as Warren Buffet once said, “Only when the tide goes out do you discover who has been swimming naked.” Once investors’ money and liquidity dries up, overleveraged firms are exposed through margin calls and bankruptcy. Cryptocurrencies with poor tokenomics or fundamentals collapse or are heavily scrutinized. And the centralized cryptocurrency exchanges such as FTX that do not hold crypto assets in proportion to the assets in customers’ amounts collapse as they can no longer honor withdrawals from the exchange.
This is why crypto investors should welcome this market collapse with open arms. Those with a long-term perspective want these bad actors in the blockchain space to be purged so that the industry can thrive over the next decade. The bankruptcies and fraud over the last months have led to a lack of confidence and record low trust in cryptocurrency.
The crypto winter rids the market of some of the worst, fraudulent companies and cryptocurrencies, so that only the best survive. This is the only way for trust to be rebuilt in the crypto communities as only the best of the industry survives and continues on to innovate the space building on the promise of cryptocurrency.
This is normal and healthy for every innovative technology and not unique to the cryptocurrency bubble that burst in 2021. Nearly every industry seems to go through these greed and fear market cycles at some point that proves beneficial in the long-term.
The dot.com bubble of the late 1990s or early 2000s is a great example of where the stock price of any company with “.com” in its name went parabolic. The internet was not yet robust or fast enough to bring ideas such as e-commerce and social networks to fruition. The technology and adoption were not quite there yet, so the internet companies trading in the stock market had little or no revenues or profits. These were just ideas at the time, rather than actual, viable businesses.
When the dot.com bubble finally burst, numerous companies without feasible, operable business models went bankrupt such as pets.com, boo.com, and Webvan. Similar to recent events in the crypto market, the stock market collapse led to several companies and their executives being accused or convicted of fraud for misusing shareholders’ money such as the communications company, Worldcom. While not an internet company, the dot.com bubble played a large part in uncovering the infamous Enron scandal.
The dot.com bubble is a great case study of how being too early for an investor can be just as detrimental as being too late. As we all know, the internet did survive the dot.com bubble and flourished to penetrate all facets of society and become integral in our daily lives. The bubble weeded out the illegitimate businesses so that only companies such as eBay, Amazon, Apple, and Google survived to finally revolutionize e-commerce, search engines, cloud computing, and smartphones.
The dot.com bubble was inevitable as there were too many companies chasing too few internet users at the time. However, even after the internet investment mania went away, the infrastructure and the online web never did. All the money that poured into internet companies during the bubble created the economic foundation and infrastructure that allowed the internet industry to mature.
The bubble was a necessary market cycle that was beneficial to internet technologies long term. When the bubble burst in 2000, there were only 400 million users. Ten years later, there were more than 2 billion internet users worldwide. The mania of the bubble helped teach us to live online.
The same forces of the dot.com bubble may be at work now in the cryptocurrency market.
Fast forward to the housing bubble and financial crisis of 2008: the gluttony of cars and houses bought with poor, cheap credit led to the housing bubble. When this bubble burst, banks were holding trillions of worthless investments in subprime mortgages. As we all know, the Great Recession followed, proving to be one of the worst economic declines in U.S. history.
As mentioned earlier, there will always be fraud and malpractice especially in industries where there is little government or state regulation. Not even banks are exempt from fear and greed market cycles when left unchecked.
Deregulation in the financial industry was the primary cause of the bubble and financial crash. Lack of regulation in the years prior to the housing bubble allowed speculation on derivatives backed by cheap mortgages available to even those with the most questionable credit worthiness.
The stock market decline and subsequent investigations exposed the rampant fraud and unethical practices in the system such as with Bernie Madoff’s ponzi scheme and the Lehman Brothers bankruptcy. This is not too different from Sam Bankman-Fried’s FTX.
It took the Great Recession and trillions of dollars being wiped out for the U.S. government to pass legislative reform and oversight such as the Dodd-Frank Act in 2010 to prevent future collapses. This regulation was the only way for citizens and the world to regain trust in the U.S. financial system again and for the world to recover.
The parallel here is that crypto investors should view the current market downturn as a catalyst for much needed regulation and reform in the space.
To be clear, governments around the world will be hesitant to regulate cryptocurrency and protect investors on their own. Many governments would rather see the asset class die to protect their power and the status quo financial systems from disruption.
However, if enough people are financially affected by the market crash, and legislative reform gains enough support among citizens, then governments may step in to provide a regulatory framework in the industry.
This regulatory clarity would allow increasingly more institutional investors to invest into digital assets. Since cryptocurrency is largely unregulated, it remains unclear if certain digital assets classify as “commodities” or “securities.” There is no single, unified regulatory authority for digital assets, and different regulators approach cryptocurrency regulation differently. Formal guidance has been the missing factor for institutions such as a lack of certainty surrounding cryptocurrency taxation and standards for stablecoins.
With or without regulation, digital assets will remain a risky, speculative asset class, but a clear framework is needed for institutional players to increase their exposure to cryptocurrency. Institutional inflows will only happen with regulatory structure in the crypto market.
Many crypto enthusiasts will protest the contradictory idea of a centralized authority regulating digital assets focused on decentralization and anonymity. However, any regulatory clarity could accelerate the evolution of the asset class and allow companies to continue delivering innovative blockchain products that transform peoples’ lives. Hopefully, use cases will become more widely adopted in ways that move beyond just storing cryptocurrency in offline, cold storage.
The difference between 2008-2009 and today is that in 2008, as major banks were at risk of bankruptcy and as fraud was being uncovered everywhere, the financial system came to a screeching halt. Massive bank runs occurred as people attempted to remove themselves altogether from the financial industry. Lack of confidence in the system discontinued banking operations and financial services came to a standstill. In the midst of the crisis, nobody knew which institutions were safe and where the counterparty risk was.
While many people continue to withdraw their funds off of cryptocurrency exchanges in droves in the wake of the FTX contagion, and investors are still capitulating on their digital assets, the major blockchains continued to operate as normal throughout this entire crisis. Unlike financial institutions during the financial crisis, cryptocurrencies such as Bitcoin and Ethereum never skipped a beat in terms of their daily functions. There were no missed or failed transactions in the Bitcoin or Ethereum blockchains, no risk of the blockchains imploding, and no issues with the Bitcoin or Ethereum ledgers despite all the fear and uncertainty.
All the illegal activity and lack of transparency was committed by the centralized companies and organizations surrounding the cryptocurrency. The decentralized cryptocurrencies and blockchains themselves were never compromised or misleading. The on-chain transactions for Bitcoin and Ethereum were transparent for all to see on the public, immutable ledgers. People were able to somewhat piece together where the counterparty risk was in the midst of the cryptocurrency crash this past year.
As the United States Federal Reserve raises federal interest rates along with other central banks to combat high inflation, the global economy is at risk of a severe recession soon. While long-term crypto investors experienced the cryptocurrency bear markets of 2011, 2014, and 2018, digital assets have never been tested by a severe economic recession. All of cryptocurrency history occurred mostly during a bull market for equities.
Crypto investors need to welcome this bear market in order to battle test the thesis for blockchain technology such as Bitcoin. We need to see that cryptocurrency and blockchains prove to be robust and infallible despite the fear, uncertainty, and doubt that will come over the next several years as economies around the world falter under the weight of the inevitable recession.
The cryptocurrencies that pass the test and validate the thesis and promise of the blockchain will most likely continue to thrive in the subsequent bull market.
In the meantime, investors should keep in mind that even with the calamities in the cryptocurrency market over the past year, Bitcoin is currently trading at 75% below its all time high of 2021, which is more or less in line with previous bear markets where Bitcoin lost 83% and 84% of its value in 2013 and 2018, respectively.
However, nothing can take away from Bitcoin’s meteoric rise and success over the past decade. It took 12 years for Bitcoin to reach 1 trillion dollars in market capitalization, and it was the fastest asset to do so. For comparison, it took Apple 38 years to reach a 1 trillion dollar market cap, Microsoft 33 years, Amazon 23 years, and Google 16 years. Bitcoin produced 230% annualized returns from 2011 to 2021.
At the time of writing, Bitcoin is trading at $17,945.10 and has been trading in a tight range between approximately $16,000 and $20,000 for months now. It’s possible that cryptocurrency prices fall much lower over the next months and years as people flee from risky assets.
Even if the downside is limited at these prices, people need to remember that “time capitulation” still needs to occur where investors will only give up on top digital assets such as Bitcoin and Ethereum if the depressed prices continue for a longer time period for us to find a true bottom.
Past price action does not guarantee that Bitcoin will succeed in the future. It truly is a speculative asset teeming with risk. It is probably still too early to compare Bitcoin to the internet or the financial system yet.
Perhaps, it is best for new or potential investors to spend time learning more about their favorite digital assets during the bear market and simply watch as the story develops.
Education and conviction will be your best guides to determine if and when to invest in cryptocurrency.
For a complete breakdown of the FTX incident, click here.