Cryptocurrencies have suffered severe losses in recent months. For example, the USD/Bitcoin exchange rate fell from nearly $70,000 at the beginning of November 2021 to below $20,000 at the end of June and, despite ups and downs, has now dropped to $19,733.
Historically, bitcoin – by far the most popular form of cryptocurrency – has been a success story for those who have bought it: the exchange rate to the dollar was below $3,000 five years ago. Nevertheless, many Bitcoin supporters have been disappointed in two aspects. The cryptocurrency has failed to become a widely accepted means of payment and has proven to be a poor purchasing power protector in times of uncertainty and inflation. This is surprising. The supply of bitcoins is limited to 21 million units. Since more than 19 million units, or 90 percent, have already been issued (“mined”), most people expected the limit to cause the dollar-denominated price to rise steadily.
What is the future?
To anticipate future scenarios for cryptocurrencies, it may be helpful to look at what has happened in the past and clarify a few key points. First, the blockchain world consists of cryptocurrencies and cryptocurrency derivatives. For example, Bitcoin is a cryptocurrency, and the stablecoins Tether and TerraUSD are derivative cryptocurrencies. They are “derivatives” of cryptocurrencies and/or are pegged to a widely recognized centralized currency, such as the dollar… Simply put, a financial investor gives dollars to a company and in return receives a derivative instrument. The company converts the dollars into cryptocurrency and lends them to global borrowers. At the same time, the company promises the financial investor to exchange the derivatives on demand for a fixed amount of a particular cryptocurrency, possibly pegged to the dollar or backed by dollars.
The upshot is that if you bought bitcoins or other cryptocurrencies, you will win/lose according to the exchange rate of the cryptocurrency in your portfolio. However, if you bought a derivative, you may find that it is not actually backed by enough cryptocurrencies or that the dollar convertibility guarantee is porous, to say the least. If so, then the derivative turns out to be virtually worthless. This is what has happened over the past few months with several cryptocurrency derivatives. Companies issuing such products are very active in the market and contribute to the underlying assets becoming volatile, especially if they promise stellar returns, which increases the demand for cryptocurrencies and crypto derivatives. If derivative products are poorly collateralized, investors are scared away in bad times.
The 2022 crash in the cryptocurrency market hit the derivatives world, possibly removing a major source of volatility.
The second key point is that cryptocurrencies are now considered a speculative tool and a source of wealth, rather than a means of payment for ordinary transactions. For example, more than 60 percent of the total number of bitcoins in circulation are held in accounts (“wallets”) with more than 100 bitcoins each, and they are rarely traded on the market except for portfolio adjustments: at the end of July 2022, only about 250,000 bitcoins were traded daily, and probably only a small fraction related to commercial transactions. Furthermore, cryptocurrency holders seem to have a long-term view. For example, both “shrimp” and “whales” (accounts with less than 1 and more than 1000 bitcoins each, respectively) took advantage of the recent sell-off to buy the drop in large quantities.
Three preliminary conclusions follow from this: (1) the long-term approach of a typical cryptocurrency holder suggests that a cryptocurrency project is not easy to kill and can withstand sharp volatility; (2) the volatility was driven by cryptocurrency derivatives, whose activity was magnified due to the relatively small number of cryptocurrencies traded on the market; (3) the 2022 crypto market crash hit the derivatives world, possibly removing a major source of volatility, killing some market drivers, hitting short-term speculators and offering opportunities to long-term crypto investors.