The Crypto Contagion and How Long It Will Affect the Market

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The traditional financial market is a global network of interconnected organizations that are mostly interdependent on each other. Therefore, the collapse of an organization could trigger a fallout of its associated businesses, and the domino ensues. The crypto industry is no different and is currently experiencing its own contagion effect that began with the collapse of Terra.

The digital asset industry is going through one of the worst years in its history. The crypto winter, which began in the first months of 2022, is still raging and has worsened over the past few months. Experts believe that this is the direct effect of a crypto contagion that sent the market plummeting and inflicted more pain on investors. But what is the crypto-contagion effect and how long will it last? Follow us to find out.

What is the crypto-contagion effect?

As you may know, contagion refers to the spread of a disease through close contact. In the financial world, contagion refers to a domino effect, where a financial crisis can spread throughout the entire ecosystem, causing serious downsides to the market. This could then trickle down to other markets, as well as other regions.

The 2008 financial crisis is a perfect example of such contagion that it triggered a global monetary crisis, probably the worst since the Great Depression.

The traditional financial market is a global network of interconnected organizations that are mostly interdependent on each other. Therefore, the collapse of an organization could trigger a fallout of its associated businesses, and the domino ensues. The crypto industry is no different and is currently experiencing its own contagion effect that began with the collapse of Terra.

Collapse of Terra (LUNA)

The crypto industry contagion effect began in May this year, with the collapse of Terra (LUNA) and its algorithmic stablecoin, TerraUSD (UST). On May 7, a series of large UST dumps on the Anchor protocol caused the stablecoin to lose its peg with the US dollar. This caused a massive FUD among investors who rushed to exit their UST positions. The sell-off sent the price of UST crashing to nearly $0.35 within days. This immediately impacted the price of LUNA (now rebranded as Terra Classic), which plummeted 96% within a week.

In the end, the combined $48 billion market capitalization of LUNA and UST was gone in a matter of days. As such, every company that invested in LUNA and UST now had a gaping hole in their books. This caused a massive contagion effect, which led to several companies suspending withdrawals, laying off employees and even declaring bankruptcy. Some of the major companies that went insolvent after Terra’s collapse include crypto hedge fund, 3 Arrows Capital (3AC) and brokerage firm Voyager Digital, as well as crypto lenders Vauld and Celsius.

The collapse of the FTX

The collapse of Terra sent crypto prices plummeting and put pressure on the entire digital asset ecosystem. And just as the market was beginning to hedge, it received another major blow, the FTX fiasco. On November 11, FTX, the world’s second-largest crypto exchange, filed for Chapter 11 bankruptcy after facing a severe liquidity crisis. However, the collapse of FTX was not something the crypto market was prepared for, and it took the industry by surprise.

The collapse of the FTX led to a contagion effect that left a hot hole in the bear market. Hundreds of companies exposed to the exchange have suffered from liquidity crises, with most of their assets being deposited on FTX. Major crypto companies like BlockFi, Genesis Capital, Gemini and others have halted withdrawals. BlockFi even had to file for bankruptcy, after which they filed a lawsuit against FTX.

Overall, these two incidents shook the industry and caused a loss of investor confidence in the market. Bitcoin has struggled to break above $17,000 since the FTX collapse and has lost nearly 65% ​​of its valuation since the start of the year. It’s a similar story with Ethereum and most other cryptocurrencies on the top 100 list. Thanks to the contagion effect, the global cryptocurrency market cap is also hovering around the $800 billion mark, a far cry from its all-time high of nearly $2.9 trillion in November 2021.

The Crypto Contagion That Started in May Could Spill Over into 2023

According to blockchain analytics firm Nansen, the collapse of FTX was likely triggered by the collapse of Terra. And experts believe what started in May 2022 could stretch into 2023. While the market seems to have stabilized after all the November chaos, the shockwaves of FTX’s fall continue to reverberate throughout the crypto ecosystem.

For example, crypto-miner Core Scientific filed for bankruptcy on December 21. Unsurprisingly, the mining giant’s collapse can also be attributed, to some extent, to the drop in Celsius. Core Scientific has provided Celsius with hosting services and claims it is owed more than $5 million. However, with Celsius filing for bankruptcy in July, those funds are effectively stuck in limbo.

Another entity struggling to shake off the contagion effect is the Grayscale Bitcoin Trust, a digital currency investment product. It recorded a 41% discount amid FTX’s collapse and that discount has only widened in the past few weeks. If things get worse, Grayscale Investments, the company that operates GBTC, could be forced to buy up to 20% of the shares of Grayscale Bitcoin Trust (GBTC).

So, the more companies affected, the longer the crypto contagion will last. However, many experts believe that the crypto market is not big enough to impact the global financial market. But if institutional investors start to sell their holdings and exit the market, the broader crypto market could be looking at further downside events and an extended crypto winter.

Conclusion

A lot needs to happen for the digital asset industry to return to its former glory, starting with widespread regulatory policies and improved security and transparency in the industry. As we head into the new year, only time will tell if the market will survive, thrive or falter.

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