This year’s dramatic decline in the cryptocurrency market was the focus of a panel at the DC Fintech Week conference, which is available both in person and virtually this week. The discussion offered some perspective on the cataclysms that began in the spring and continued into the fall.

In September, various cryptocurrencies fell by around 60% year-to-date, with even Bitcoin down 65% in that time from its November 2021 highs.

Predictions about how long this crypto winter might last, whether the thaw has begun or not, and what long-term effects it might have are still changing.

At the conference, Lily Frankus, Chief Investment Officer of Novi Loren, was joined on stage by Colleen Sullivan, Co-Head of Private Equity at Brevan Howard Digital. Mary-Catherine Lader, COO of Uniswap Labs, went virtual for the Crypto Winter Price Risk and Opportunity panel. Chris Brummer, founder of DC Fintech Week, moderated.

“This crypto winter for me is quite different than the last,” Sullivan said. “On the trading side in January 2018, it was pretty clear that we had a problem.” During the previous crypto winter, the big crypto arbitrageurs of the latter half of 2017 had disappeared, she said, and proprietary trading firms had entered the space. It took until the third quarter of 2018 for bearish trends to reach the risk side, Sullivan said. “We really didn’t know we were in a real bear market until about then.”

This year, however, crypto winter is behaving differently, she said. “While we saw some volatility in the growth stages in mid-February and March, we thought that was mostly related to the global macro environment and what was happening to tech stocks,” Sullivan said. “You hit the 9th of May, Terra depegs, and it’s like you’ve gone from one realm to an entirely different realm.”

Over the course of a week in May, the Terra stablecoin and the Luna cryptocurrency linked to the Terra blockchain collapsed in an implosion that wiped out about $45 billion in market capitalization.

“It was just a violent re-evaluation of all the stages, right down to the preliminary phase,” Sullivan said. There were other cascading events, she said, including the bankruptcies of crypto brokerage firm Voyager Digital, crypto lender Celsius Network and crypto hedge fund Three Arrows Capital. “I think it’s remarkable that Bitcoin and Ethereum have held up as well as they have. It was very different — it was much sharper than the previous one,” she said, comparing the latest decline to the previous crypto winter.

While she wasn’t worried that crypto would disappear wholesale, the suddenness of this year’s declines has shaken some expectations. “You have institutions that you think have better risk management than what it turns out they have,” Sullivan said. “These were not crypto issues per se. They were poor risk management issues and some fraud mixed in.

Validating DeFi

Lader said this crypto winter has given some validity to decentralized finance (DeFi), which are protocols that have some kind of decentralized governance or can run on a decentralized technical architecture. This could include self-executing smart contracts on the blockchain that require no human operation, she said.

“What we’ve seen over the past year … the big challenges have been traditional risk management challenges,” Lader said. “They were often organizations that had centralized risk management functions, centralized liquidity management, that didn’t commit to the practices that are well known in traditional financial services as critical to managing people’s assets.” In the world of DeFi, she said, there is complete transparency about what is happening with the assets, whether it is an individual, a retail investor or a large-scale institution.

“Now in crypto winter, the challenge is to focus on building and using this time of less market frenzy and less enthusiasm around specific crypto assets, instead making these services available to more people,” Lader said. There are difficulties in trying to use DeFi that still persist, she said, such as too many friction points in the user experience and it being too complicated to explain how they work. “We in the industry haven’t done a good job of explaining why the ability to hold your own assets or the ability to exchange transparent and reliable infrastructure is any different or better,” Lader said.

She sees opportunities this crypto winter for DeFi companies to facilitate the use of these services and better explain why they have advantages in reducing systemic and other types of market risks that can be replicated in the centralized financial infrastructure that has suffered in the past six to nine months.

Risk Quantification

Frankus talks about metrics to quantify risk and opportunity in crypto markets. She also said there is a lack of industry-accepted as well as regulatory-accepted metrics and frameworks for understanding risk. “Many of the issues we’ve seen this year in crypto markets parallel pretty well what’s happened in traditional markets before,” Frankus said. “The long-standing joke is that it’s almost like ants discovered space travel — that they just accelerated the history of traditional financial markets by about 10 years.”

A significant downward pressure seen in May, she said, was that institutional players had hidden exposures to counterparties that were either functionally insolvent or were severely damaged by the Terra and Luna implosion. “At the institutional level, a lot of these larger players — the genesis is that they’ve pulled out a lot of their leverage that they’ve been lending to these counterparties,” Frankus said.

If anything, this crypto winter has exposed some of the over-funding and hype poured into the crypto space that is akin to some old, frothy, bad habits of the startup scene. “You see not only on the risk side, funding teams without proper vetting, but even on the institutional side or the lending side, that many of these players who were considered the blue chips or the centralized players in the crypto markets were not manage their loan portfolios properly,” Frankus said. “They generated fantastic profits because the markets were full of dumb money.”

There isn’t enough understanding of the damage that can be done, she said, some of which can be attributed to the relatively short history of crypto markets. Still, the crypto collapse exposed some bad actors. “Part of it also comes from sheer greed,” Frankus said.

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