Have the bad apples all fallen off the crypto tree?

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Traditionally decoupled from broader market movements, we are now seeing a closer correlation between the crypto market and the macro economy, with many cryptocurrencies behaving like other risky assets such as stocks.

The Role of Crypto in Macroeconomics

With no indication that global macro pressures will ease, along with an expected correction of at least 10-20% in stock prices, we perhaps shouldn’t expect a meaningful price recovery. of cryptography by the end of the year. On the other hand, we have seen central banks tighten monetary policy faster than we have seen in recent years, so it will be interesting to see what effect this may (or may not) have on crypto prices. .

The influence of broader market conditions on crypto was perhaps best seen in The Merge. Despite all the efforts to jack up prices with the promise of lower power consumption, reduced operating costs and the “air-dropping” of the ETHPOW Token, this event was technically much more successful than generating positive price momentum. While it can be argued that some initial selling pressure on ETH price was fueled by PoW miners selling their inventory, the finger is still firmly pointing to uncertainty in the macro economy. As long as interest rates and inflation continue to rise, risky assets such as cryptocurrencies will find it difficult to decouple from the market in a sustainable way.

Decoupling crypto and macroeconomics

The recent volatility of crypto markets has been fueled by large institutions that have gone insolvent, numerous hacked protocols, and catastrophic events such as the collapse of Terra-Luna. As a result, many investors have become much more cautious and aware of the risks associated with crypto. While we can expect this sentiment to continue for some time, once there is clearer regulation, as well as the development of use cases and utility for different crypto assets, we should expect see a substantial increase in crypto included as part of the investment. portfolios for retail and institutional investors.

When crypto as an industry matures further and the number of active users within the crypto economy continues to grow, we expect there will be an opportunity for crypto to decouple of the broader market for risky assets. Of course, this still depends on the significant improvement of the macro environment; as long as there is uncertainty on the future of the wider economy, it will be difficult for sentiment around crypto and other risky assets to improve as well.

The crypto lending market

The highly publicized collapses of Voyager, Three Arrows, and Celsius in 2022 certainly sent shockwaves through the crypto community, but they may be the catalysts needed to better align crypto markets with traditional finance (TradFi).

The regulations will most certainly get tougher, bring crypto market operators closer to TradFi operators. We should start to see more comprehensive internal risk management functions from crypto providers, and investors are now much more likely to demand transparency about where and how their allocations are stored and used. . We believe that all successful players in the market place these considerations at the heart of their business going forward.

That being said, unsecured lending will most certainly continue to be a part of the crypto industry in the future, just as it is in TradiFi today; without this accelerated activity, we would see a slowdown in innovation. What will change, however, is a rise in risk management and the proper pricing of risk in unsecured lending. We are already seeing this in the market today, with many crypto providers hiring TradFi industry risk management teams to be more compliant.

While it is tempting to view secured lending as the airtight option to ensure trust and security in the market, this still relies on a better level of transparency from crypto operators and improved regulation in the market. industry. Just look at recent exploits in Challenge to see that secured lending cannot rely solely on the value of crypto; collateral can be manipulated if the token is illiquid, and events like a full stock market crash can completely wipe out all value. It would be positive to see a move towards the standardization of loan contracts that we see at TradFi; the inclusion of covenants on loans would be only one measure among others that would create products that are easily comparable to each other. Again, operators can also help build confidence in the industry by releasing financial data and giving indications of future business expectations.

The lending and earning of interest on surplus assets and the borrowing of scarce assets are essential pillars of any functioning market; they optimize the economy by ensuring that assets are directed to where they are needed most. Borrowing offers market operators who engage in different activities in the market a profitable way to carry out these activities, while lending offers other market operators a way to utilize their excess assets and earn a interest on them rather than letting them sit idly by their wallets.

In today’s crypto market, we find that market makers and market-neutral hedge funds generate the best returns from the lending ecosystem, and thus most lending activity is centered around these players. Traders with excess capital also get the best risk-adjusted returns by directing their capital into crypto. In the future, it may be Decentralized Autonomous Organizations (DAOs) looking to invest in building crypto infrastructure, or a new product used by billions of people or investment managers, that will generate the best risk-adjusted returns, in which case most of the money will be directed here.

The outlook for 2023

A potential rally in the crypto market depends on a number of macroeconomic metrics that are still highly uncertain. However, we see that most of them are already priced in, and many of our used indicators suggest that the bottom of the market may be near. For example, the supply of Bitcoin in profit on October 13, 2022 is at the same level as during the Covid crash and the bear market trough of 2018-2019. We expect some sort of recovery over the next year, but it remains to be seen how strong the engines are to maintain positive momentum. Again, much depends on the macroeconomic environment, as risky asset prices are unable to sustain a long recovery if rate hikes continue or we enter a recession.

The crypto industry has a history of hostility towards regulation but, when done well in a collaborative way, regulation helps create a safer and more trusted market with better standardized practices. It also improves market efficiency, which is necessary if the industry really wants to challenge banks, asset managers and other industry players in the TradFi world.

The crypto industry as a whole is currently at a tipping point: what we as an industry decide to do next is what determines the success or failure of our industry and the crypto as a whole. Only by welcoming regulation, providing transparency to customers, regulators and other stakeholders, and ensuring proper risk management can the crypto industry seek to change the current sentiment and better align with the requirements of traditional finance.

Other contributors to this article were from the DeFi team at tesseract. tesseract is an institutional digital asset lending company in Europe and emerging markets that provides digital asset lending solutions to institutional clients, such as hedge funds and retail trading platforms, worldwide.

By Daniel Staford and Lauri Marekwia, DeFi Team at Tesseract