Why is the Crypto Market Down?
For almost all of Q1 2022, crypto was going sideways without a decisive moment. Yet recently, the market faced a dramatic downfall, with many left puzzled about the forces driving such a vertical downward movement. Let's dive into reasons why this is happening.
At the moment, global instability reached every corner of the planet. Take a close look at the rising inflation as a result of Covid-19. Global inflation has accelerated, reaching 9.2% in March of 2022.
In the US alone, inflation rose above the level of the 2008 financial crisis, reaching 5.4% in July 2021, climbing to 8.3% in April. The additional factor was the aim of the American state to support its business by injecting more cash into the economy and avoiding hiking up interest.
"As inflation erodes the value of a dollar of earnings, it can make it difficult for the market to gauge the current value of the companies that make up market indexes. Further, higher prices for materials, inventory, and labor can impact earnings as companies adjust. As a result, stock prices can fluctuate, and this causes volatility" - Nationwide
In a nutshell, rising inflation questioned the value of corporations listed on stock exchanges, leaving traders and investors wondering how to rebalance their portfolio.
The Russian invasion of Ukraine created even more uncertainty around the world – after all, Russia is the largest oil and seed producer. Surging petrol and food prices pushed global inflation further. Consequently, in March 2022, the feds agreed to raise the interest rate by 0.25% and later in May 2022 by 0.5%. That also meant a hike in credit APR, a rate at which companies lend funds. Finally, the negative market sentiment coupled with rising petrol and food prices led to a stock sell-off.
Crypto is highly correlated with stocks due to the involvement of large institutional investors in the market. Thus, if stocks fall, a crypto crash happens. But that's just one part of an equation.
The Fall of Luna
The second major event that influenced crypto is UST. By now, you've probably heard about the collapsed stablecoin. Here's what happened.
The overall stablecoin support system was run on an algorithm supported by Luna, a cryptocurrency from the Luna Foundation Guard (LFG). UST was also Luna’s token. Here's how the algorithm worked: if UST was merely losing its peg to USD, the holders had a chance to swap the token for a dollar worth of Luna, effectively burning UST. The system worked well for a while, but some experts warned of its flaws in the past. There were cases in the past when algorithmic stablecoins were losing all their value instantly. In the last few months, it was reported that Do Kwon, the founder of Luna and UST, bought $3.5 bln worth of Bitcoin in an effort to support the stablecoin.
And it happened. On the 7th of May, a massive amount of UST and Luna were sold on exchanges, pushing the price of both tokens down. The panic outburst led to even more sales, with holders unable to exchange 1 UST for 1$ worth of Luna. As UST was collapsing, an algorithm was minting more and more Luna, eventually driving its price down from $85 to $0.0001871.
UST now is trading around $0.15. The event hurt the crypto market. It created even more uncertainty and fear. As of now, the Bitcoin fear and greed index stands at the Extreme Fear mark. Wall Street Journal, citing analysts, writes that a 10% dip in the BTC price results from a fear that Luna Foundation Guard will flood the market.
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