Into the Cryptoverse: The Downfall of Crypto?
What is crypto?
To understand the current trends in the cryptocurrency market, we need to understand what exactly cryptocurrency is. Cryptocurrency (or ‘crypto’) is a digital currency designed to work as a medium of exchange through a computer network called the blockchain. In the blockchain, a decentralised network refers to the transfer of control and decision-making from a centralised entity to a distribution network such as individuals, organisations, or governments. Decentralised systems aim to reduce the level of trust that participants place on each other and deter the overall ability to control the functionality of the network.
What benefits does a decentralised system have?
- Provides a trustless environment
- No one must know or trust anyone, given that each member has the same data set as a distributed ledger.
- Reduce points of weakness
- Implementing a decentralised system can reduce points of weakness where there might be a high reliance on specific facilities (e.g. stockbrokers or trading platforms), which can lead to system failures.
- Improves data reconciliation
- When data is transferred, it facilitates opportunities for data loss. However, having a decentralised data store allows all involved parties to access a real-time, shared view of the data.
However, implementing a decentralised system also comes with its downsides which include
- Potential for elicit activity
- Since transactions are untraceable as there is no governing body, it allows criminals to wash their dirty money and participate in illegal trade.
- Increased risk of crypto fraud
- As there is no central governing body, the potential risk for crypto fraud becomes more prevent.
Over the past few months, crypto has seen a dramatic pullback in prices, with some coins such as Bitcoin and Ethereum reaching record highs of $68,000 and $6,335 in November 2021. However, over the past few months, those coins have seen significant decreases in value, with Bitcoin currently being $30,500 and Ethereum being $2,900.
The current crypto forecast looks bleak with the sudden crash felt throughout the ‘crypto sphere.’ Bitcoin, regarded as the market leader within the crypto market, fell to below $27,000 USD losing 8% of its overall value in 24 hours during the crash on the 11th of May 2022. As such, this significant drop in Bitcoin rippled through the rest of the crypto market, with estimates of over $200bn of capital wiped out from the total value of crypto during the crash, causing the largest cryptocurrency exchange platform in Binance to suspend its trading, due to the severity of the market crash.
What caused this crash?
The crash was triggered by the stablecoin Terra USD (UST). This cryptocurrency was pegged to the USD, thus maintaining an almost identical value to the dollar. However, the coin lost its peg to the USD dollar and whipped out the support of its non-stable coin partner Luna, causing drops of 100% in total market value, consequently losing billions of dollars in just a few days. Major sell-offs caused this with customers trying to withdraw their position, which the Luna algorithms could not keep up with, which forced the Luna foundation (operator of Terra Luna) to sell their bitcoin reserves to raise enough liquidity to try and save the stablecoin. However, the significant sell-off in Bitcoin injected a surplus, which devalued Bitcoin and thus created mass panic among investors, creating a ripple effect that induced a greater market pullback.
How could this happen?
So how could a cryptocurrency, ranked among the world’s top 10 most valuable cryptocurrencies and peaking close to $120 last month, now be worth $0.000146 as of the 19th of May 2022? There have been many speculations on the driving point for this crash, with some investors blaming the sudden drop on a large entity who may have dumped billions of Luna Terra into the market, which shattered its peg for the dollar forcing mass panic within the market. Alternatively, people have speculated that Luna Terra crashed because algorithmic stablecoins were built to fail. They relied heavily on consistent demand and did not account for human cognition, which experts suggest would work theoretically but not in a free market with uncontrollable variables.
Long term impacts
What does this crash mean for crypto in the long term? Firstly, this crash will continue to add new levels of uncertainty regarding the crypto market, as investors will be wearier of coins - those that sound too good to be true. Secondly, a crash of this magnitude will continue to put downwards pressure on the reputation of cryptocurrency, with investors seeing crypto less as a legitimate way to invest their money but more to ‘gamble’ their money in hopes of more significant monetary benefit. Finally, this crash will enforce the notion that crypto should continue to be monitored by a governing body to ensure that such events are mitigated, thus protecting the investors from crypto developers.
Tips to better protect yourself.
Given the uncertainty associated with cryptocurrency trading, new investors should consider the following tips to ensure such fluctuations can be effectively dealt with:
- Do extensive research on the coin and who produced it.
- Diverse your portfolio into different coins to allocate risk
- Avoid thinking in the short-term mindset of getting ‘rich quick.’