2021 was a year where the sun shined brightly upon crypto investors. By November 2021, Bitcoin had reached an all-time high of $69,000, breezing through with a market cap of $3T. Few could have imagined what was in store for Crypto and DeFi in 2022.
It was not long before things turned from bolt to blue, with the crypto market plummeting below , $2T in January 2022 following interest rate revisions by the Federal Reserve. It was only an unfortunate downward spiral thereupon. Currently, the crypto ecosystem is tied up by a string of hacks and swindlers – causing investors to second-guess its “trustless” foundation.
Market experts call this period of market-freezing conditions ㅡ “crypto winter”, and in this post, we’ll explore what caused the polar vortex in the crypto ecosystem.
How Did The Crypto Winter Set In?
Cryptocurrency prices are prone to wild volatility. It has always been a market that’s hot today, cool tomorrow. The year’s crypto ecosystem collapse has largely been caused by the failure of crypto “banks”, crypto exchanges, and crypto hedge funds.
Exhibit 1 shows how crypto companies ultimately went from high-flyers to skydivers in 2022.
The world of crypto went into a tailspin when TerraUSD and its sister coin Luna collapsed. This event had severe repercussions for not just its investors but also the overall crypto market. In the aftermath, businesses suffered a great deal.
The Singapore-based crypto hedge fund, Three Arrows Capital, was one of the many that fell victim to the same. The company wasn’t just heavily exposed to Terra-Luna but had also taken out loans that it couldn’t repay after the collapse. When Three Arrows collapsed, massive holes were blown in the balance sheets of companies like Voyager as well. The crypto lending platform Celsius went out of business too. Celsius explained its liquidity woes later in its bankruptcy filings as a result of LUNA’s failure.
In the midst of what was thought to be the worst crypto disaster of the year ― FTX collapsed ─ posing yet another existential threat to the crypto market. Following Binance’s withdrawal from the acquisition deal, things went south for FTX. On November 11, 2022, FTX filed for bankruptcy. Adding insult to injury, user wallets were drained of hundreds of millions of dollars shortly after the exchange filed for bankruptcy.
If there’s one thing that all of these companies have in common is ― centralisation. Typically, these centralised lenders and centralised exchanges operated like a “black box” that allowed little transparency for borrowers and investors. And eventually, when these black boxes came under pressure from industry sleuths and regulators, the crypto story rapidly came crashing down into the dumps.
Cryptocurrencies were once touted to be the next big thing in financial services, but the risks they bring are nothing new — wherever there is money, raiders are bound to prowl. Exhibit 2 showcases a glimpse of the biggest hacks in the crypto ecosystem in 2022.
In October 2022 alone, $718M has been stolen from DeFi protocols, pushing the gross value to over $3B and putting 2022 on track to be a record year for hacking, according to blockchain specialist Chainalysis’s tweet. Attackers exploited vulnerabilities in smart contracts and protocols, particularly cross-chain bridges and flash loan protocols, to commit the biggest crypto attacks of 2022. While most CeFi platforms were the victims of shutdowns, DeFi players were the hardest hit when it came to crypto hacks. Hackers were able to successfully break into its code, security, and structure.
The DeFi ecosystem cannot attain its full potential if the very decentralisation that makes it so dynamic is also responsible for widespread scams and thefts. A proactive approach to smart contract security is the best way for most DeFi projects to ensure their names do not appear in the headlines.
Tussle with the “Trustless”
Crypto was built on the concept of “trustlessness”, i.e. cryptocurrency transactions and holdings don’t require trust from third parties, such as governments, central banks, or other financial intermediaries.
Today, cryptocurrency’s trustless aspect appears to be under a massive strain. In order to prevent exploiters from setting up shop in this space, either regulation must be enacted, or the infrastructure must be powerful enough to deter their activities. Probably both are the need of the hour.
It will be interesting to see how regulators clamp down on the bad actors in the crypto ecosystem and how the industry manages the rising pressure of consumers’ distrust, investors’ pessimism, and regulatory scrutiny. 2023 is expected to be a year when the crypto industry would need to brace for courtroom depositions, contagion risks, and clean-ups.