Regulatory policy

Cryptos Face Growing Pressure; lack of policy clarity remains a headwind

The last two months have seen a spectacular cryptocurrency bear market. This comes after a long bull run, which has multiplied the cryptocurrency’s market value, attracted new investors and led serious investment houses to create crypto indices and advise portfolio exposure to digital currencies.

The value of cryptocurrencies peaked in early mid-November 2021. Since then, most coins have fallen and it is estimated that over $1 trillion in market value has been wiped out. Take the two largest assets: Bitcoin is down 44% from its peak and it’s up around 6% in the last 12 months despite the correction; Ethereum lost 46% but is still up around 77% from January 2021 levels.

What are the causes of the slowdown? First of all, it is important to note that cryptocurrencies are not pegged to anything and their prices are purely a function of supply and demand. There is no central agency controlling the money supply – it increases by an exact mathematical amount, known to all participants. There is no interest rate, let alone a key rate. Unlike fiat currency, cryptos cannot even be compared to the economic performance of the issuing country.

Therefore, these digital assets are solely driven by sentiment. If sentiment is strong, prices can shoot up like they did in 2020 and 2021. If sentiment is weak, we can see this type of catastrophic fall. Apart from weak sentiment, we also have a situation where many crypto traders may have decided to take profits.

During this period, global equity markets also experienced corrections, ranging from 8 to 10% in most major markets. These declines are motivated by fears, now more or less confirmed by the last meeting of the FOMC (Federal Open Market Committee), that the United States will tighten its monetary policy to fight against inflation. If the Fed tightens, so will other major central banks facing high inflation. This leads to an attitude of risk.

There are also fears specific to cryptocurrencies. One is government regulation and oversight. China has banned the trade; India has drafted legislation that is somewhat ambiguous and can be interpreted either as banning the entire asset class completely, or as selectively banning many cryptos and only allowing trade in a few pennies. careful monitoring.

China and India are both home to large crypto-trading communities, which are now uncertain about the future.

A drop in crypto prices may lead to popular support for increased regulatory pressure – more citizens will demand oversight, and governments might be happy to comply. Environmentalists are also pushing to stop crypto-trading or drastically change algorithms.

Verifying transactions on the blockchain and mining new coins are computationally intensive, performed by syndicates using server farms with special chips. The carbon footprint is huge. After China ban, unions change location.

There are environmental pressures to shut down or change mining procedures for lower carbon intensity. Suggested changes to proof-of-work mining could make cryptos more vulnerable to fraud, and the money supply could be more easily controlled by a few large consortia.

For all these reasons, the asset class is currently under pressure and should remain so until the most pressing political issues are resolved. The assessment that crypto is an alternative asset class, which can be a hedge, remains valid. But portfolio theorists betting on that will have to allow for the extreme volatility we’ve seen over the past 3 years.

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