The traditional financial market is a global network of interconnected organizations that are mostly interdependent with each other. Therefore, the collapse of one organization could trigger a collapse of its associated companies, and the domino effect occurs. 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 early months of 2022, is still going on and has gotten uglier in recent months. Experts believe this is the direct effect of a โcrypto contagionโ that has sent the market into a tailspin and inflicted more pain on investors. But what is the crypto contagion effect and how long will it last? Tag 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 ecosystem, causing severe market disruption. This could then impact other markets and regions as well.
The 2008 financial crisis is a perfect example of such contagion: it triggered a global currency crisis, probably the worst since the Great Depression.
The traditional financial market is a global network of interconnected organizations that are mostly interdependent with each other. Therefore, the collapse of one organization could trigger a collapse of its associated companies, and the domino effect occurs. The crypto industry is no different, and is currently experiencing its own contagion effect that began with the collapse of Terra.
Earth Collapse (MOON)
The contagion effect of the crypto industry began in May of 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 to the US dollar. This caused massive FUD among investors who rushed out of their UST positions. The selloff sent the price of UST plummeting to almost $0.35 in a matter of days. This immediately affected the price of LUNA (now renamed Terra Classic), which fell 96 percent in one week.
In the end, the combined $48 billion market cap of LUNA and UST disappeared in the span of a few days. As such, any company that invested in LUNA and UST now had a huge hole on their books. This caused a massive contagion effect, resulting in several companies pausing withdrawals, laying off employees, and even filing for bankruptcy. Some of the major companies that filed for insolvency after the Terra collapse include cryptocurrency hedge fund 3 Arrows Capital (3AC) and brokerage firm Voyager Digital, along with cryptocurrency lenders Vauld and Celsius.
The FTX Collapse
The Terra collapse caused cryptocurrency prices to plummet and put pressure on the entire ecosystem of digital assets. And just as the market began to cover, it took another big hit: the FTX fiasco. On November 11, FTX, the world's second-largest cryptocurrency exchange, filed for Chapter 11 bankruptcy after facing a severe liquidity crisis. However, the FTX crash was not something the crypto market was prepared for and it took the industry by surprise.
The FTX collapse led to a contagion effect that left a burning hole in the bear market. Hundreds of companies that were exposed to the exchange suffered from liquidity crises as most of their assets were held on FTX. Major crypto firms like BlockFi, Genesis Capital, Gemini, and others stopped 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 investors to lose confidence in the market. Bitcoin has been struggling to break out of the $17,000 mark since the FTX crash and has lost almost 65 percent of its valuation to date. It's a similar story with Ethereum and most of the other cryptocurrencies in the top 100 list. Thanks to the contagion effect, the global cryptocurrency market capitalization is also teetering around the $800 billion mark, a far cry from its all-time high of nearly $2.9 trillion in November 2021.
The cryptocurrency that began in May could last until 2023
According to blockchain analytics firm Nansen, the FTX collapse was likely triggered by the Terra collapse. And experts believe that what started in May 2022 could extend into 2023. While the market appears to have stabilized after all the chaos of November, the shockwaves from the FTX crash continue to reverberate throughout the crypto ecosystem.
For example, cryptominer Core Scientific filed for bankruptcy on December 21. Unsurprisingly, the collapse of the mining giant can also be attributed, to some degree, to the drop in Celsius. Core Scientific provided Celsius with hosting services and claims it is owed more than $5 million. However, with Celsius filing for bankruptcy in July, these funds are effectively stuck in limbo.
Another entity that is struggling to shake off the contagion effect is the Grayscale Bitcoin Trust, a digital currency investment product. It posted a 41 percent discount amid the FTX crash and this discount has only widened in recent weeks. If things get worse, Grayscale Investments, the company that operates GBTC, could be forced to buy up to 20 percent of the shares of Grayscale Bitcoin Trust (GBTC).
As such, the more companies that are 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 facing a further slowdown in events and a prolonged crypto winter.
Conclution
A lot needs to happen for the digital asset industry to return to its former glory, starting with widespread regulatory policies and increased security and transparency in the industry. As we head into the New Year, only time will tell if the market will survive, thrive, or disappear.
