Crypto contagion deters investors in near term, but fundamentals stay strong

Many experts believe that the recent slew of insolvencies may be good for the market in the long run, weeding out any weak players from the industry.

The past six-odd months have been nothing short of a financial soap opera for the cryptocurrency market, with more drama seemingly unfolding every other day. To this point, since the start of May, a growing number of major crypto entities have been tumbling like dominoes, with the trend likely to continue in the near term.

The contagion, for the lack of a better word, was sparked by the collapse of the Terra ecosystem back in May, wherein the project’s associated digital currencies became worthless almost overnight. Following the event, crypto lending platform Celsius was faced with bankruptcy. Then Zipmex, a Singapore-based cryptocurrency exchange, froze all customer withdrawals, a move that was mirrored by crypto financial service provider Babel Finance late last month.

It is worth noting that since December 2021, nearly $2 trillion have been wiped out from the digital asset industry. And, while markets across the board — including equities and commodities — have been severely affected by the prevailing macro-economic climate, the above-stated slew of collapses have definitely had a role to play in the ongoing crypto drain. To this point, Ben Caselin, head of research and strategy for crypto exchange AAX, told Cointelegraph:

“The contagion has played a big part in the recent downturn, but we cannot ignore the wider market conditions and the change in fiscal policy as important factors playing into price. The situation concerning Celcius, Three Arrows Capital but also Terra is expressive of an over-leveraged system unable to withstand severe market stress. This should in the least serve as a wake up call for the industry.”

He went on to add that increasing mass adoption of digital currencies in the future should be done by expanding the scope of crypto beyond its prevailing “sound money narrative.” Caselin highlighted that the market as a whole now needs to take into account and implement financial practices that are sound and sustainable in the long run.

What do the recent insolvencies mean for the industry?

Felix Xu, CEO of decentralized finance (DeFi) project Bella Protocol and co-founder of ZX Squared Capital, told Cointelegraph that the past month has been a “Lehman moment” of sorts for the crypto market. For the first time in history, this industry has witnessed the insolvency of major asset managers such as Celsius, Voyager and Babel Finance within a matter of months. 

According to his personal research data, while ailing projects like Voyager and Genesis collapsed due to the fact that they had the most exposure to Three Arrows Capital (3AC), the collapse of 3AC, Celsius and Babel Finance emanated due to rogue management practices associated with the assets of their users. Xu added:

“I believe the first wave of forced liquidation and panic selling is now over. As asset managers and funds file for bankruptcies, their crypto collaterals will take a long time to be liquidated. On the other hand, DeFi lending platforms such as MakerDAO, Aave and Compound Finance performed well during this downturn, as they are over-collateralized with strict liquidation rules written into their smart contracts.”

Going forward, he believes that the crypto market is likely to move in correlation with other asset classes including equities, with the industry potentially taking some time to rebuild its lost investor confidence. That said, in Xu’s opinion, what happened last month with the crypto market is nothing new when it comes to the traditional finance space. “We’ve seen it in the 2008 financial crisis and the 1997 Asian financial crisis,” he pointed out.

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Hatu Sheikh, co-founder of DAO Maker — a growth technologies provider for nascent and growing crypto startups — told Cointelegraph that the aftermath of this contagion has been strongly negative but not for the reason many people would imagine:

“A key loss here is that many of the cenrtalized finance platforms that went bankrupt due to the contagion were active onramps to the industry. Their unsustainable and often deceptive means of attracting new industry participants brought millions of people to trickle deep into nonfungible tokens and DeFi.”

In Sheikh’s view, while DeFi onboarding may come to a halt or at least slow down in the near term, many venture capital firms operating within his space have already raised billions and are thus capable of continuing to inject funds into many upcoming startups. “We’ll have a new roster of companies that’ll replace the lost ones’ role of being an onramp to the industry,” he said.

Undisputed damaged to the market’s reputation 

Misha Lederman, director of communications for decentralized peer-to-peer and self-custody crypto wallet Klever, told Cointelegraph that the recent crash has definitely damaged the reputation of the industry but believes that the aforementioned insolvencies have helped cleanse the industry of bad players, adding:

“This presents a huge opportunity for blockchain platforms and crypto communities with a responsibility-driven approach to innovation, in which user funds are protected at all costs. As an industry, we have to be better than the fiat debt system we aim to replace.”

A similar opinion is shared by Shyla Bashyr, public relations and communications lead for UpLift DAO — a permissionless and decentralized platform for token sales and swaps — who told Cointelegraph that the industry has been hit hard and is currently shrouded with more negativity than ever before. 

However, she believes such scenarios are sometimes needed since they present new opportunities to build transparent products that provide additional insurance, hedging and security for peoples’ investments.

Sheikh pointed out that while there’s rampant criticism that DeFi apps have lost billions, it is worth noting that the losses accumulated by CeFi lenders are notably higher:

“The fact remains that the notable blue chips of DeFi have remained mostly unscathed, yet the losses in CeFi are from industry leaders. However, as crypto CeFi is a stepping stone in people’s journey to DeFi, the industry’s adoption will be steeply hurt in the short term.”

He concluded that the “CeFi contagion” could eventually prove to be a powerful catalyst for the growth of its decentralized counterpart as well as a validation of crypto’s core use case, such as being self-sovereign wealth. 

The future may not be all bad

When asked about what lies ahead for the crypto market, Narek Gevorgyan, CEO at CoinStats, told Cointelegraph that despite the prevailing conditions, the market has already started showing promising signs of recovery, stating that institutional investors are back on the playing field and exchange inflows are on the rise. 

In this regard, banking titan Citigroup recently released a report stating that the market slide is now in recession, with researchers noting that the “acute deleveraging phase” that was recently in play has ended, especially given that a vast majority of large brokers and market makers in within the industry have come forth and disclosed their exposures.

Not only that, the study also shows that stablecoin outflows have been stemmed while outflows from crypto exchange-traded funds (ETF) have also stabilized.

Gevorgyan believes that the trust investors had built up over the last couple of years has been somewhat dissolved due to recent events. Nevertheless, the blockchain community is still better funded than at any point in its short history, with development most likely to continue. He then went on to add:

“The Terra implosion triggered a meltdown that brought several CeDeFi platforms down with it. The community has become more aware of the shortcomings of the CeDeFi model. Overall, the string of insolvencies has provided the crypto market with a chance to start afresh, as DeFi2 and Web3 are continuing to become more significant. Maybe the Metaverse will take center stage in this new configuration.”

CeFi vs DeFi

Sheikh believes that the best of CeFi has lost more than the worst of DeFi, highlighting that Bitcoin (BTC) has continued to remain one of the most liquid assets in the world. In his view, the next wave of retail adopters will have glaring references to the problem of skipping self-custody, thus paving the path for greater focus on decentralized apps, especially as the market continues to mature.

On the other hand, Bashyr sees a lot of protected projects such as insurance protocols and hedged products flourishing from here on out. In her opinion, decentralized autonomous organizations (DAOs) will become more prominent and functional, providing real governance and allowing users to participate in instrumental decisions by voting on proposals that make a difference.

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Lastly, in Xu’s opinion, the insolvencies have resulted in millions of users calling for regulations like those governing traditional finance within the global crypto economy so as to increase transparency on investment of user assets. Xu added that since DeFi benefits from no single point of control while offering full transparency and autonomous rules, it will eventually take over the crypto asset management business.

Therefore, as we head into a future plagued by economic uncertainty, it will be interesting to see how the future of the crypto market plays out. This is because more and more people are continuing to look for ways to preserve their wealth — thanks, in large part, to the recession fears that are looming large on the horizon — and therefore consider crypto to be their way out of the madness.