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Crypto Crash: What investors need to know?
A "flash crash" in cryptocurrency prices occurs when many holders of a specific crypto-asset suddenly decide to sell off their holdings, outnumbering the number of purchasers and driving down prices over time. In contrast to a typical crash, this event tends for the price to rebound fast, frequently finishing with the price near its initial level. Traditional finance is where the phrase "flash collapse" originated. The most well-known incident occurred in 2010 when a British trader was detained for his part in the abrupt decline of the US stock market.
The causes of the cryptocurrency market crash
1. At $1.6 trillion, the total market value has plummeted to a ten-month low.
- Total market capitalization for cryptocurrencies has reached its lowest point in ten months. Over the weekend, an additional $130 billion departed the market, bringing the market size down to $1.62 trillion. According to CoinGecko, it hasn't been this low since early August.
- During the Monday morning Asian trading session, losses are once again led by Bitcoin (BTC) and Ethereum (ETH). Ethereum is down 4.2% to $2,443, its lowest price since January, while Bitcoin has lost a further 3.1% to $33,486 at the time of writing.
- Although cryptocurrency markets are cyclical, there are now a few more variables contributing to the selloff.
2. Fed increases interest rates
- Last week, the Federal Reserve increased interest rates by half a percentage point, and Wall Street's stocks fell as a result. Following suit, the cryptocurrency market has lost more than 10%, or about $200 billion, during the previous week.
- Senior market analyst at Oanda Edward Moya observed that the Nasdaq and cryptocurrency markets have strong correlations. He said that while Bitcoin is down 22% this year, the tech-focused index is down 21%. The asset has primarily been consolidating for the majority of this year, and Moya noted that confidence is low.
3. Interest among institutions declining
- Extremely positive conditions existed for institutional cryptocurrency investment in 2021, but those conditions did not last into 2022. The entry of well-known companies like Tesla, MicroStrategy, El Salvador, and other payment systems into the cryptocurrency market fueled the demand and momentum. Even more favorably, regulators permitted trading in the first Bitcoin futures exchange-traded funds.
- This year has been much more restrained, and according to CoinShares, institutional crypto fund outflows have occurred for four weeks. Moya claims that institutional and corporate investors have a "wait-and-see approach."
What investors need to know?
Bitcoin might not be the best hedge against inflation
The cryptocurrency market has been growing with the stock market for the past few months. In March 2022, the correlation between Bitcoin and the S&P 500 reached a peak of 17 months, showing that the markets for cryptocurrencies and stocks are heading in the same direction.
A popular hedge against inflation is bitcoin. Inflation, thus, has no impact on the leading cryptocurrency. At least, based on what the market experienced this past week, it might not always be the case. Investors in cryptocurrencies were impacted by high inflation and a stricter monetary policy, which caused the market to crash. These incidents show how the bitcoin business is growing and becoming more well-known.
Not All Stablecoins Are Stable
The value of stablecoins is intended to remain stable. They are backed by fiat money, such as the US dollar, gold, and others, in addition to other cryptocurrencies. The Bitcoin crash had a significant influence on Terra and TerraUSD. This is due to Terra's business model.
Terra (LUNA) and TerraUSD are the Terra network's native coins (UST). By employing algorithms, TerraUSD seeks to keep its peg to the US dollar. As a result, the equivalent amount of LUNA in dollars must be burned to make UST. The protocol works in this way to keep the price of UST stable.
According to TechCrunch.com, the Luna Foundation Guard (LFG), which established Terra, wanted to add Bitcoin to its reserve in March 2022 to give its stablecoin more cushions. The concept was that UST would be stabilized by Bitcoin backing if something went wrong with the pricing. Sadly, it didn't happen, and as a result, the stock market, Bitcoin, and ultimately the whole crypto market crashed.
Stablecoins are cryptocurrencies whose value is tied to another coin, item, or financial instrument. Unfortunately, the extreme volatility of the most widely used cryptocurrencies, such as Bitcoin (BTC), has rendered such assets less suited for widespread usage in transactions. Stablecoins attempt to offer a solution to this situation.
How did it crash?
A corporation issuing a stablecoin must have its dollar equivalent in reserve as collateral to assure the security of these loans. However, TerraUSD substantially elevated the risk of its operation becoming out of balance by depending on a novel approach called algorithmic and providing its second token as collateral-the erratic Terra Luna.
Thus, everything fell apart. However, there were plenty of cautionary statements. Iron Finance, a comparable enterprise, had failed similarly a year prior. Stable currencies generally arouse a lot of skepticism. The most valuable token, Tether, was already pinned in 2019 because it could not demonstrate that it has dollar reserves equal to those of its tokens.
This week's crypto meltdown provided a wealth of lessons. Even the most popular alternative currencies, like Terra, may experience sudden losses and struggle to survive. TerraUSD and other decentralized algorithm stablecoins offer a fascinating theory but require a more successful strategy. In times of crisis, centralized stablecoins like Tether (USDT), which are frequently accused of having insufficient currency reserves, appear powerless. This will be remembered as a turning point in the history of the cryptocurrency sector and a reminder to fans that more work still needs to be done.
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