Crypto crunch: what’s next?

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The recent crisis may, as crises frequently do, lower expectations to healthier, more realistic levels, separate the wheat from the chaff, and allow viable projects to continue to develop. A parallel with the 1999-2000 dot-com crash surely has limitations as, in the late 1990s, the internet was already more mainstream and was providing more useful services than cryptocurrencies today. But it is a reminder that some of today’s blue-chip tech stocks also experienced very brutal price collapses before thriving. Moreover, while most cryptocurrencies only have a short history, the approximate 75% peak-to-trough price decline of Bitcoin in 2021-22 was not its first and Bitcoin has already been declared ‘dead’ many times.

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Ethereum, the N°2 cryptocurrency, transitioned smoothly in September 2022 from a proof-of-work to a new proof-of-stake mining process, an expected event (yet previously seen as fraught with operational risks) that drastically reduced its energy consumption, making it much more ESG-compatible. As of today, nearly all major ‘Layer 1’ blockchains (intended for the deployment of ‘smart contract’ dynamic applications) are proof-of-stake, meaning that the energy consumption matter has become much more specific to Bitcoin than a broader cryptocurrency issue. Moreover, Ethereum’s transition will be followed by further upgrades which should bring more scalability and reduce transaction costs, while other major ‘Layer 1’ blockchains also have upgrades in the pipeline.

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Despite the incidents of 2022, the key value propositions of cryptocurrencies (decentralisation, the immutability of transactions and, for some of them, the predetermined limited supply) were left mostly unscathed. Indeed, many of the troubles involved centralised third parties, be they exchanges, lenders or hedge funds, that brought with them the typical rogue finance behaviour seen many times before in other asset classes, primarily excessive leverage, poor risk management or outright fraud. On the contrary, and most importantly, DeFi (which enables automated transactions between peers without trusted intermediaries) generally continued to function well, despite the fall in value locked. Some DeFi applications have proved vulnerable to hackers, yet this is a well-known and generally accepted risk to investors. Interruptions to mainstream blockchains’ transaction processes have only been very temporary.

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Interest from heavyweights in the financial and other industries may have slowed somewhat, but has not stopped, be it for cryptocurrencies or, even more so, for digital assets and tokenisation. True, it was in 2021 when most of the spectacular events took place that brought traditional finance and cryptocurrencies closer, notably major crypto exchange Coinbase’s IPO on the Nasdaq and the launch of the first US Bitcoin futures-based ETF, two events that more-or-less coincided with the two historic peaks of the market. Yet 2022 also witnessed further developments on this front, with Blackrock acquiring a stake in Circle (the company issuing the USDC stablecoin) and the integration of its Aladdin platform with Coinbase. Several further experimental bridges were launched between digital and traditional assets by finance and banking actors, such as the issuance of digital versions of mainstream bonds, the possibility to borrow stablecoins against traditional collateral, or the use of cryptocurrencies as collateral for traditional loans. Thus, it can be argued that the very visible price pressure on cryptocurrencies has not stopped the quieter, yet potentially more disruptive momentum toward the tokenisation of assets.

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Regulation will certainly cause other temporary price setbacks but is more likely than not to be a positive in the end. While two years ago, the outright banning of cryptocurrencies in large, advanced economies was still seen as a possibility, the regulators eventually chose not to go down this road. On both sides of the Atlantic the need for comprehensive regulation for risk mitigation has been stressed (notably President Biden’s ‘executive order’ in March 2022 and the more advanced EU’s MICA regulation) and now appears more urgent following the FTX collapse. Yet fostering a competitive digital asset sector is more and more seen as a necessity to preserve the rank of national financial sectors in global competition. Regulating cryptocurrencies remains very much in the making and is complex, due to the many issues involving investor protection, money laundering, tax evasion, sovereignty, and energy consumption, which can lead to contradictions and be addressed by different agencies. Rules may also continue to lag the rapid advance of technologies. However, it is still only a matter of time before the sector becomes considerably more regulated than it currently is, something that will deter some investors, yet is likely to make the market look safer to others. On the other side, crypto bans by a number of emerging economies’ authorities often appear unconvincing, not watertight and have sometimes been reversed.