Cryptos Are Rising, But a “Crypto Winter” Could Be Coming

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Venture capital is also flooding the crypto space. The time of dreams

Bitcoin and other cryptocurrencies rallied on Thursday as investors snapped up stocks and other risky assets after days of selling pressure.

Bitcoin was ahead 2.3% in afternoon trading at $43,000. Ether, Solana, Terra and other major tokens also rallied, pushing the overall market up 2.3% to $2 trillion in market value, according to CoinMarketCap.

Google is developing a new blockchain unit, according to a Bloomberg News report, in the latest sign that Big Tech is looking to leverage the crypto economy.

Shivakumar Venkataraman, vice president of engineering at Google, leads a unit focused on blockchain and other next-generation distributed computing and data storage technologies, Bloomberg reported.

Google, the main division of Alphabet (ticker: GOOGL), did not immediately respond to a request for comment.

Venture capital is also flooding the crypto space. One of the biggest players, Andreessen Horowitz, is aiming to raise $4.5 billion for a new fund dedicated to blockchain-based businesses, according to the Financial Times.

According to Pitchbook, more than $30 billion in venture capital and other forms of private equity flowed into crypto startups in 2021, up more than seven times from 2020.

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Yet capital may be flowing into crypto at a difficult time for the industry and technology in general. Investors have grown nervous over rising interest rates as the Federal Reserve tightens monetary policy. Highly valued tech stocks were punished. Cryptos also suffered; the overall market has lost a third of its value, or $1 trillion, since peaking at $3 trillion last November.

Tighter monetary policies are one of the many reasons why UBS, in a research note published on January 14, warns of a second crypto winter. The last such winter of 2018 saw Bitcoin and other cryptos fall over 75% from previous peaks. It then took them about three years to return to previous highs of 2017.

According to UBS, cryptos took off in 2021 in part due to abnormal monetary policies that flooded global markets with excess liquidity. But central banks should gradually normalize their policies, putting pressure on alternative currencies like Bitcoin which have been boosted by the associated excess liquidity.

The idea that Bitcoin is a store of value in an inflationary climate is also coming under greater scrutiny, according to UBS. While sovereign fiat currencies can lose purchasing power in an environment of high inflation, their supplies are adjustable to contract and expand with economic growth and other variables.

This flexibility can help sovereign currencies retain their value over the long term, unlike bitcoins that are limited in supply and constrained by volatility to be able to function as units of account or mediums of exchange, according to UBS.

Another headwind is that blockchain technology may take a while to reach mainstream financial markets, if it ever does. Blockchain networks like Bitcoin began as decentralized ledgers, aiming to improve the security, transparency, and accessibility of incumbent payment systems dominated by banks and other institutions. But the Bitcoin network itself is centralized as the miners, who operate the network, consolidate.

Additionally, many of the newer blockchains are controlled by corporations and entities, and the industry is shifting to a proof-of-stake model for transaction processing potentially centralizing networks in the hands of a few large operators.

Blockchains do not develop in practice without morphing into the same plutocratic systems they were designed to replace, says UBS. Blockchains are also vulnerable to hacks, fraud, and theft, and they are far from being widely adopted due to the technological complexity of even changing an account’s password.

Finally, speculative excesses increase as blockchain-based applications and services attract more users and economic value, they will inevitably invite closer regulatory scrutiny. High-flying stablecoins and DeFi projects look all but certain to face bigger setbacks from authorities in the coming months, according to UBS.

The conclusion is not necessarily that cryptos will crash overnight, losing value like the Dutch tulips that never had much use. Venture capital is pouring in because blockchain technology could be revolutionary, opening up new venues for trading and securities borrowing as well as whole new ways to monetize digital collectibles with non-fungible tokens, or NFTs.

But the market may be increasingly demanding which crypto and blockchain companies will survive as liquidity dries up, leaving less capital for everyone.

Write to Daren Fonda at [email protected]

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