Is the crypto market staring at pullbacks in 2022?

Highlights

• History suggests that with every major upswing in the crypto market, a fall in the market usually follows
• Although crypto has previously been seen as a hedge against the wider market, the digital asset hasn’t done well when the stock market hasn’t performed well
• If crypto performs poorly in the coming year, the brokerages offering the loans could want the investor to put up more collateral. Worse yet, they may demand the sale of any assets the in-debt investor holds

For all the ups and downs the cryptocurrency space has experienced in the past 12 months, it’s been a great year for crypto market overall. The worldwide lockdowns, imposed by governments wishing to stamp out the transmission of the Covid-19 virus, saw an influx of new investors looking to replenish lost income.

In fact, the total combined value of all digital currencies has risen to US$2.14 trillion this year – a 176 percent increase. Despite this year’s growth, there are concerns that the crypto market will experience a major pullback or even a crash in the coming year.

1. What Goes Up Might Go Down

History suggests that with every major upswing in the crypto market, a fall in the market usually follows.

Take 2017 for example – the last year in which the market saw a considerable rise. Between March 2017 and January 2018, the crypto’s total market value saw a 35-fold increase. However, throughout the rest of 2018, the market would lose nearly 90 percent of its total value.

Why does this happen? Well, the massive spikes are almost always driven by speculation resulting in an overvaluation. The drop-off is the market correcting itself as to the true value of various cryptocurrencies' services.

That begs the question: What is the true value of cryptocurrency? Blockchain technology, upon which all cryptocurrencies are built, provides a world of possibilities that haven’t, yet, been properly realised.

Decentralised finance (DeFi), which cryptos like Ethereum and Solana provide, offer the opportunity for a more democratised finance system, through its omission of third-party institutions, like banks, in its transactions.

Image Source: © Jozefmicic | Megapixl.com

2. Crypto’s Tie to The Stock Market

Although crypto has previously been seen as a hedge against the wider market, the digital asset hasn’t done well when the stock market hasn’t performed well.

Crypto’s often been dubbed “digital gold”, as capped cryptos, like Bitcoin, which has a maximum supply of 21 million coins, are designed to protect investors against inflationary costs.

However, during the stock market decline in 2018, which saw the S&P 500 decline by 20 percent, the crypto market also experienced a drop of around 40 percent.

The Covid-19 pandemic has resulted in interruptions to the supply chains, which, in turn, has increased inflation. In November, the US inflation rate grew to 6.8 percent - the highest rate since June 1982.

While the 6.8 percent figure represents the inflation across the entire market, some sector’s inflation rates grew more considerably. For example the energy sector recorded the biggest gain of 33 percent in November versus 30 percent in the previous month.

With inflationary costs predicted to continue its rise in 2022, this will likely be reflected in the fall of the stock market, which may well impact the crypto market.

3. Margin Debt To Come Calling

Up until this point, the crypto market has been a joyous free-for-all with investors able to leverage up to 100 times their cash position when trading Bitcoin on certain crypto exchanges.

The money that investors borrow to purchase crypto assets is what’s known as a margin. If an investor uses a margin to purchase crypto and that crypto increases in value over the short term, that’s good for the investor. However, if the crypto’s value decreases, that margin still has to be paid back in full.

If crypto performs poorly in the coming year, the brokerages offering the loans could want the investor to put up more collateral. Worse yet, they may demand the sale of any assets the in-debt investor holds. A sell off like this could compound crypto’s downward trajectory.

Bottom Line

Of course, another year of positive growth for the crypto space would be great for investors. Realistically, those same investors have to be considering the very real possibility of a poorer performance in 2022. Exactly how poor the market will perform, if at all, will be answered in 2022.