On the 15th of November 2021, the price of Bitcoin reached an all time high of $65,521. A year later in November 2022, bitcoin’s price had dropped by two-thirds all the way to $16,440. So what happened? Why did we go from a crypto frenzy in 2021 to a complete crypto crash and bear market in 2022? In this article, I explore why the crypto market crashed in 2022 and the landmark events that led up to it.
- From a macro perspective, the crypto market crash of 2022 broadly correlates with the stock market. As the central bank started to raise rates to tackle high inflation, markets anticipated a downturn. The crypto market followed suit and started pointing South in January 2022.
- The collapse of Terra LUNA in May 2022 exacerbated the bear market sentiment and sent giant reverberations across the crypto world as $47Bn vanished into thin air.
- The first boat to sink after Terra LUNA implosion was 3 Arrows Capital which was overexposed to LUNA. This vanquished another $3.5Bn from the market along with 27 creditor companies
- The final domino was the FTX collapse in November 2022 which wiped out another $400Bn from the market.
In order to understand the crash we first need to take a look at the macroeconomic perspective.
Why Crypto Crashed in 2022: A Macro Perspective
In February 2020 the world experienced its first major pandemic in 100 years.
The last one was the Spanish Flu of 1918-1920.
We had kind of forgotten what pandemics were like and all hell broke loose as governments around the world tried to figure out how to deal with the ensuing chaos.
As global trade and travel came to a standstill markets did what they do best: they freaked out.
All major indices crashed as traders predicted doomsday scenarios.
By March 2020 the S&P500 had dropped 31%. The last time that had happened was in the housing market crisis of 2008.
Crypto followed suit. The total crypto market also dropped by about 30% from $278 Bn to $152 Bn.
Now this is interesting.
Crypto and Bitcoin in particular are supposed to be uncorrelated to the broader market.
Bitcoin supporters will tell you that Bitcoin is like digital gold.
The story goes like this:
Bitcoin’s superior properties to other forms of money mean that it will become the world’s way to store value. As a result, bitcoin is the place to store your money during hard times.
However, the market did not play out like that. Instead, Bitcoin and the broader crypto market followed the stock market.
It turns out that digital assets are often highly correlated with major indices for long periods of time.
Governments to the rescue
If you are a careful reader and have been paying attention to the graphs you will have noticed the markets bounced back very soon after the COVID crash.
By August 2020 we were back where we started after which the markets experienced a major bull run even though COVID was ongoing.
Why is that?
Well, governments announced stimulus packages and vaccinations.
In the US and countries around the world where people had lost their jobs, the stimulus meant people received paychecks from the government.
But where did the money come from?
To prevent a financial crisis governments printed immense amounts of money and lowered interest rates to 0.
Money printer goes Brrr
And when you have loads of money floating about in an economy and it’s free to borrow then you end up with two things
- People don’t want to hold on to cash because its value will get diluted so they invest it. Since bonds offer 0% return they invest it in stocks
- There is a lot of appetite for risk. Why not invest in that Netflix stock that your friend saw good returns on? And why not try crypto which is what everyone is talking about these days?
Both the stock market and crypto markets experienced a stupendous bull run all the way up to December 2020. Had you invested in the S&P500 in March 2020 you would have almost doubled your money by December.
More impressively, the total crypto market capitalization grew 17 times!
If you had picked any cryptocurrency at random chances were you did well.
This is why you had so many friends and acquaintances acting like they were a market sage.
There was all sorts of advice floating about on Twitter and other social media about which was the hottest crypto to invest in and the crypto FOMO was off the charts.
But all good things must come to an end.
Inflation has been climbing since mid-2021.
Turns out Governments over printed and supply chains remained constrained, especially with China, the factory of the world, cracking down hard on COVID with prolonged lockdowns.
In January 2022 the US Federal Reserve and other central banks started hinting at rate hikes which they started doing in the spring of 2022. This caused stock indices to dip as they anticipated rougher times ahead.
The market further panicked in February when the Russia-Ukraine war broke out.
Crypto followed the trend.
The narrative that bitcoin is a hedge against inflation did not hold.
Instead, bitcoin and crypto holders saw the value of their investments take multiple hits as the risk-on appetite dwindled and investors sought refuge in safe-haven assets such as treasury bonds that now paid a higher rate.
So far we’ve looked at things from a macro lens. But if you zoom in you’ll see there were all sorts of things that were imploding on the way down.
In this next section, I will walk you through some of the landmark events that helped to topple the cryptocurrency market in 2022.
Major events that led to the crypto market’s downfall in 2022
OK, so we talked about the broader market downturn that led to a corresponding decline in January 2022.
But then a few things started to happen that would end up being somewhat interconnected. Let’s take a look at some of the major events.
#1. The market gets overheated by February 2022
Prior to the collapse of crypto last year, a new expression was starting to float around crypto forums: “DeFi 2.0.”
DeFi stands for Decentralized Finance and refers to the multitude of protocols that offer financial products without a central intermediary.
For example, you’ve got lending and borrowing (e.g. Compound), decentralized crypto exchanges (e.g. Uniswap), stablecoins (such as DAI ), investment optimization (e.g. Yearn Finance), and derivatives.
This was a lot of financial innovation at a rapid speed.
Crypto enthusiasts were buoyant as these new “financial rails” were coming into place.
Extreme interest rates
But then a new protocol emerged called Olympus DAO that did something different.
Unlike other protocols, Olympus started offering extremely high interest rates when you invested in their protocol.
With Olympus DAO you could earn in excess of 1,000% in annual yield.
Of course, this return was in their own cryptocurrency of which they could print as much as they wanted and according to their terms.
Nevertheless, the high-interest rates attracted a lot of capital.
Copycats soon caught on to the idea with many simply copy-pasting the Olympus DAO code.
Almost overnight you had about 100 similar protocols attracting capital in this manner.
One of these copies, built on the Avalanche blockchain, was a DAO (Decentralized Autonomous Organisation) called Wonderland.
They took things to the extreme by offering 80,000% interest!
The Wonderland Scandal hits the crypto market in February 2022
Wonderland’s token was called $TIME and its public face was a well-known crypto influencer called Daniel Sesta.
In January 2022, @zachxbt, a well-known Twitter user who is respected for uncovering scams, announced that he had found out the real identity of Wonderland’s treasury manager.
It didn’t look good.
Going by multiple names but born as Omar Dhanani this person had been convicted and spent time in jail for credit card fraud amongst other crimes.
What’s more, Dhanani was the co-founder of Quadriga, a popular Canadian exchange that collapsed after its other co-founder died under suspicious circumstances on a trip to India.
There is a documentary on Netflix about Quadriga which is pretty scandalous.
This article goes into more detail but in a nutshell here is how things ended up:
While Sesta tried to assuage traders, the market reacted negatively to the news. The protocol had already experienced a liquidation cascade by being overleveraged during the market downturn.
But $TIME and other tokens that Sesta was associated with such as $ICE, $MIM, $MEMO, and $SPELL took a further hit when the news about Dhanani broke out and people started likening this crypto platforms to Ponzi schemes.
There was something rotten with the state of crypto. The Wonderland debacle was only the first crack in the crypto market of 2022.
More was to come.
#2. Terra LUNA collapses in May 2022
The Jenga block that caused the crypto market’s demise in 2022 was the collapse of the Terra-LUNA protocol in early May.
At the time Terra UST was the third largest stablecoin. A stablecoin is a cryptocurrency that pegs itself to the US dollar. So 1 UST = 1 USD.
Except that the peg did not hold.
On the 8th of May the price of UST which had been steadily trading at $1 started to shift.
At first, it started trading at around $0.98.
On the 9th it reached a bottom of $0.95.
But, by the 13th of May 2022, it had dropped all the way to $0.17.
The third largest stablecoin had lost its peg and collapsed wiping out $47Bn in market cap.
If you want to really understand the details I explain how Terra LUNA worked and how it collapsed in my post below:
The important point to keep in mind is that a major DeFi protocol that was thought to be robust and the future of finance disappeared within a few days thus wiping out loads of people. This sent jitters throughout the crypto space.
Companies that were exposed to UST and its LUNA cryptocurrency would be soon feeling the repercussions as we shall see below.
#3. Three Arrows Capital Implodes in June 2022
One of the funds that believed in the future potential of Terra and had a large exposure to it was 3 Arrows Capital (3AC).
In fact, 3AC was so convinced that Terra was the future that they had borrowed money to invest in it.
3AC was founded in 2012 by two rookie bankers, Kyle Davies and Zhu Su, who left Credit Suisse to ride the crypto wave.
They were extremely successful and at their peak managed an unbelievable $18Bn in assets.
However, towards the end of June 2022, major financial news outlets such as the Financial Times and Wall Street Journal reported that 3AC was failing to make its margin calls and repayments to creditors.
Turns out 3AC had been overexposed to the Terra LUNA collapse and the bucket was starting to leak. In turn, 3AC’s creditors started having trouble.
Like dominoes one company after another started to collapse wiping out $3.5Bn in market value. In total 27 companies were affected including major players such as Celsius Network and Voyager Digital who both went bankrupt shortly after.
CryptoSlate reports on the 3AC collapse in more detail.
The 3AC reverberations were massive but just when everyone thought things had started to stabilize another major crypto player imploded.
#4. Crypto exchange FTX collapses in November 2022
In November 2022 a weird exchange happened between Binance CEO, Changpeng Zhao (CZ) and FTX CEO, Sam Bankman-Fried.
In a peeved tweet CZ accused Sam of lobbying against Binance with crypto industry leaders behind CZ’s back and announced that Binacee would be selling a sizeable amount of FTT (FTX’s native token) that they held.
CZ says this was for risk management purposes following what happened with Terra LUNA in the past.
This sent the price of FTT tumbling.
The problem is that FTT didn’t really do anything. It didn’t have any utility so the only thing propping its value up was the crypto exuberance and hype.
Shortly after CoinDesk published research indicating that Sam’s Quantitative Trading Firm, Alameda Research had about $5Bn worth of FTT on its balance sheets.
As the FTT price started to drop traders became spooked and started removing liquidity from the exchange. FTX sought to raise a bailout from investment funds including Binance. But after some rudimentary due diligence, Binance figured it did not want any part of FTX.
This further exacerbated the situation. Over time it came to be known that Sam had moved $10Bn worth of customer funds to Alameda. It also became apparent that he used these funds to buy luxury items, finance advertising with celebrities, and make political donations.
About a month later the Bahamas issued an arrest warrant for Bankman-Fried. From there he was extradited to the US.
In total, the FTX meltdown wiped out about $400Bn from the market. The full repercussions are still being felt as a lot of these assets will be liquidated in the coming weeks. Some fear this will put further downward pressure on the markets and that it will be a while before we exit this crypto winter.
So why is cryptocurrency worth anything? Really now. I can’t meet any of my everyday needs with it. Can’t buy coffee. Can’t buy groceries. Can’t buy shoes or clothes. I can’t pay my utility bills or Netflix subscription. I can’t pay my mortgage installments with it, medical expenses or private school fees for my kids. I can’t use it on vacation or for transportation. The whole damn thing sounds pretty useless to me. They should remove the word “currency” from the term and stick with “crypto”. Or even better christen it “Cryptic” because no one really understands what this thing is about in the first place. Read more.