4 things to know when cryptocurrencies like Bitcoin (and stablecoins) are melting

As the old saying goes, sometimes the bigger they are, the harder they fall.

During the pandemic, bitcoin and other cryptocurrencies grew, turning many amateur investors into millionaires, at least on paper. For example, in November, bitcoin reached almost $ 68,000 for all time.

Today, it is trading less than half that amount as part of an intensive sell-off that has accelerated in recent weeks.

Even worse was the area of ​​cryptocurrencies called stablecoins, particularly the one called TerraUSD, which fell sharply.

Here’s a look at what’s going on.

So why are cryptocurrencies so declining?

Simply put, cryptocurrencies have fallen into a vortex that affects broad markets.

Stocks, bonds and other assets have fallen in recent weeks as investors fear the Federal Reserve will need to aggressively raise interest rates to fight inflation, raising the prospect of a recession.

The fall in broad markets has affected cryptocurrencies, p Bitcoin down more than 20% in the last two weeks.

The sell-offs were even worse for some new cryptocurrencies, such as Dogecoin, which started as a joke and then started, in part thanks to the support of billionaire Ilona Mask.

This is a sharp reverse compared to a few months ago when actors like Matt Damon and Larry David represented crypto companies in a Super Bowl commercial.

Wasn’t bitcoin supposed to be a protection against inflation?

Yes, but it hasn’t turned out, at least not yet.

Bitcoin was the first cryptocurrency and still remains the most popular of all.

Proponents of bitcoin have long touted the digital currency as a hedge against inflation, in part because its numbers are limited.

But bitcoin has fallen sharply, along with stocks.

If bitcoin was seen as a real insurance against inflation, it would have to come together, given that inflation is at its highest level in decades.

“A lot of people thought it was going to be inflation hedging, but there’s really very little evidence to support that,” says Randy Frederick, CEO of Charles Schwab, a cryptocurrency company. “More recently, it hasn’t moved up as the market has moved down. If it was hedging inflation, it could do it. ”

In fact, Bitcoin reacts just like any other risky asset, such as stocks.

However, the argument of bitcoin as a hedge of inflation is also not entirely dead, experts say.

Bitcoin may be the oldest of the cryptocurrencies, but it has only existed for just over ten years.

This means that analysts do not have much historical data. Frederick, for example, says we will know a lot more about how bitcoin behaves through more market cycles.

What about stablecoins?

Cryptocurrencies have spawned branches and led to more complex – or, as some regulators see them, dangerous – assets.

Stablecoins, such as Tether or USD Coin, are a type of crypto that is gaining in popularity.

Most stablecoins are designed to provide real assets. This means that for every dollar of a stablecoin exchange or seller, you will need to set aside an equivalent in real fiat currency, such as dollars, or an equivalent amount in securities that are easy to trade, such as government bonds.

This is what should make them more “stable”. If a stablecoin buyer wanted to cash out this virtual currency, it should be easy, as the exchange should have money on hand, just as bank customers expect to withdraw their money at any time.

But regulators have long questioned whether exchanges really keep these solid assets in the account. Moreover, stemcoins have created their own branches.

One of them, TerraUSD, has been in big trouble in recent days. TerraUSD is known as an algorithmic stablecoin because it relies on financial engineering to maintain a 1 to 1 binding between the stablecoin and reserve assets.

TerraUSD is even pegged to another cryptocurrency called Luna.

As of Friday, stablecoin had fallen to 14 cents, well below $ 1, which should theoretically be profitable.

Pat Chosik, a senior portfolio strategist with Ned Davis Research, says TerraUSD’s problems could be part of a potential cryptocurrency withdrawal.

“It’s still very young,” he says of the crypt. “You know, this is still a developing area. There will be assumptions. There will be ups and downs along the way, and it’s still new. “

So where do we go from here?

In a broader sense, the prospects for cryptocurrencies are likely to continue to be tied to broader market sentiment.

But the fall in cryptocurrencies and the fall in the value of TerraUSD are alarming politicians such as Finance Minister Janet Yellen and Securities and Exchange Commission Chairman Gary Hensler.

This may lead to greater regulation of cryptocurrencies in general.

The steady decline of cryptocurrencies may also raise doubts about the future of virtual money in a broader sense, just as signs appear that they are trying to mature and more and more professional investors are starting to trade them.

Last month, Fidelity, the largest provider of retirement plans, announced it would allow employers to offer bitcoin in 401 (k) plans, although the Department of Labor warned employers against this.

However, cryptocurrencies also have many fanatical fans who are accustomed to sharp sales and reversals, and many believe it is a short-term downturn.

For example, Chesik of Ned Davis Research is “long-term tuned to bitcoin,” he says. “We still see that acceptance of this continues to expand.”

It points to millennials, for example, who want to invest in cryptocurrencies because they look like a “legitimate option”.

However, not everyone agrees that leaves the future of cryptocurrency uncertain.

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