2022 saw a series of crypto meltdowns that is reshaping the industry

After peaking in November 2021, crypto assets suffered a S$3 trillion wipe-out in the following 12 months. PHOTO: REUTERS

PORTLAND, Oregon – The history of cryptocurrencies has rarely been dull, but the meltdown of 2022 delivered a series of shocks that shook the foundations of digital assets.

A cascade of blow-ups, including the collapse of the so-called algorithmic stablecoin TerraUSD in May and the epic unravelling of the FTX crypto exchange in November, left a wave of bankruptcies.

The events eroded the trust of more mainstream investors, who were eager to capitalise on rising interest in Bitcoin and the vision of decentralised finance. The turmoil has prompted calls for regulators to move more urgently to protect consumers.

1. What happened to crypto prices?

After peaking in November 2021, crypto assets suffered a US$2.2 trillion (S$3 trillion) wipe-out in the following 12 months, with their combined market value tumbling by 73 per cent, according to data from tracker CoinGecko. In the past, such collapses – also known as “crypto winters” – were triggered by events within the industry itself, such as the failure of an exchange or a regulatory crackdown. This one began with something external: Central banks hiking interest rates to combat a post-pandemic surge in inflation, which reduced investor appetite for riskier assets, including crypto.

2. What is the significance of that?

The collapse exploded the idea that crypto enjoys a similar status to gold as a refuge in times of economic uncertainty by being decoupled from the fortunes of traditional financial assets. It was a shock to pension and sovereign wealth fund managers – and millions of small investors – who embraced crypto in recent years on the conviction that it was becoming a mainstream asset class.

It turned out that the crypto rally of 2021 was built on shaky foundations because many investors borrowed heavily to wager on digital coins and projects, often using other crypto as collateral. That interconnectedness spread the impact of high-profile failures.

3. What blew up?

The biggest explosion involved TerraUSD – a digital token whose value was meant to be pegged to the US dollar through the use of a parallel currency, Luna.

It became popular when users of a decentralised finance platform called Anchor were offered interest rates as high as 20 per cent for TerraUSD deposits. Sudden withdrawals from Anchor drove TerraUSD’s value down, and within days, both it and Luna had entered a death spiral that wiped about US$60 billion off their value.

Companies that had invested in related tokens and derivatives, such as Three Arrows Capital, ended up going bankrupt, leading to failures of other companies, such as Voyager Digital, which had given Three Arrows a massive loan.

In November, there was yet another shock: the implosion of star entrepreneur Sam Bankman-Fried’s crypto empire, including one of the biggest crypto exchanges, FTX. In the space of a few days, Mr Bankman-Fried, who had bailed out other struggling crypto ventures and become an unofficial ambassador for the industry at conferences and in the United States Congress, saw his US$15.6 billion fortune evaporate. FTX had a tangled web of related entities, including trading house Alameda Research, with lax record-keeping and poor centralised controls.

4. What were the consequences?

Critics said many crypto projects were doomed to fail as they relied in part on offering unsustainable returns. They likened some high-yielding ventures to new forms of Ponzi schemes, funding payouts to existing investors using deposits from new ones. The implosion of FTX underscored the dangers of contagion, in which problems in one corner of the industry spread fast and in unexpected ways, triggering huge losses elsewhere.

All this could freeze investment in crypto for some time.

5. Where does this leave the industry?

Crypto was invented in the wake of the 2008 global financial crisis, which eroded trust in traditional institutions. But the string of scandals in 2022 raises what amounts to an existential question of whether crypto can be trusted, either.

To many, the hope was that stricter regulation could restore confidence. But the FTX bankruptcy seemingly derailed legislation that had been lobbied for heavily by Mr Bankman-Fried. It had been opposed by some operators of DeFi platforms, who saw it as skewed toward the interests of big, centralised exchanges like FTX.

Tougher regulation may eventually make crypto a more stable and respectable investment. What is not clear is how much of the industry can withstand the kind of scrutiny that would entail. BLOOMBERG

Follow ST on LinkedIn and stay updated on the latest career news, insights and more.