The cryptocurrency market has been in a downward trend since May, when a series of negative events triggered a massive sell-off. The market capitalization of all cryptocurrencies has fallen by more than 50% from its peak of over $2.5 trillion, and many investors are wondering if the crypto winter is here to stay.
We will explore some of the key themes that are defining this crypto bear market, and how they affect the outlook for the industry. We will also share some insights from our portfolio manager, who oversees the VanEck Vectors Digital Assets Equity ETF (DAPP), which invests in companies that are involved in the digital asset’s ecosystem.
Theme 1: Regulatory uncertainty
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One of the main factors that has contributed to the crypto market slump is the regulatory uncertainty in various jurisdictions. Many governments are still grappling with how to regulate cryptocurrencies and related activities, such as mining, trading, custody, and taxation. Some countries, such as China, have taken a harsh stance and banned crypto-related activities altogether, while others, such as the US, have adopted a more nuanced approach and issued guidance on specific aspects of the industry.
The lack of clear and consistent regulation creates challenges for both investors and businesses in the crypto space. Investors face the risk of losing access to certain platforms or services, or having their assets seized or frozen by authorities. Businesses face the risk of being shut down or fined for non-compliance or having to relocate to more favorable jurisdictions. This uncertainty also discourages innovation and adoption, as many potential users and developers may be deterred by the legal risks involved.
Our portfolio manager believes that regulation is inevitable and necessary for the crypto industry to mature and gain mainstream acceptance. He also believes that regulation can be beneficial for the industry, as it can provide clarity, legitimacy, and protection for both investors and businesses. He expects that regulators will eventually adopt a balanced and proportional approach that recognizes the potential benefits of crypto, while addressing the legitimate concerns of financial stability, consumer protection, and national security.
Theme 2: Environmental concerns
Another theme that has weighed on the crypto market is the environmental impact of cryptocurrency mining. Mining is the process of validating transactions and creating new coins on a blockchain network, such as Bitcoin or Ethereum. Mining requires a lot of computing power and electricity, which generates a significant amount of carbon emissions. According to some estimates, the annual energy consumption of Bitcoin mining is comparable to that of some medium-sized countries, such as Argentina or Norway.
The environmental impact of crypto mining has attracted criticism from various stakeholders, including environmental activists, policymakers, and institutional investors. Some prominent figures, such as Tesla CEO Elon Musk, have publicly expressed their concerns about the carbon footprint of crypto and withdrawn their support for certain coins. Some governments, such as China and Iran, have also cracked down on crypto mining due to its impact on the power grid and the environment.
Our portfolio manager acknowledges that crypto mining poses an environmental challenge that needs to be addressed by the industry. He also notes that there are solutions that can reduce the energy consumption and emissions of crypto mining, such as switching to renewable energy sources, improving energy efficiency, or adopting alternative consensus mechanisms that do not rely on mining. He believes that these solutions will become more prevalent and viable over time, as the industry evolves and responds to market demand and social pressure.
Theme 3: Technological innovation
The third theme that is defining this crypto bear market is the technological innovation that is happening in the industry. Despite the market downturn, the crypto space is still witnessing rapid development and experimentation in various areas, such as decentralized finance (DeFi), non-fungible tokens (NFTs), layer-2 solutions, interoperability protocols, and central bank digital currencies (CBDCs). These innovations aim to improve the functionality, scalability, usability, and diversity of the crypto ecosystem.
DeFi refers to a range of financial applications that run on decentralized platforms, such as smart contracts or blockchains. DeFi enables users to access services such as lending, borrowing, trading, investing, and insurance without intermediaries or centralized authorities. DeFi has grown exponentially in the past year, reaching over $100 billion in total value locked (TVL) at its peak in May.
NFTs are unique digital tokens that represent ownership of scarce digital assets, such as art, music, games, or collectibles. NFTs have exploded in popularity this year, generating billions of dollars in sales and attracting mainstream attention from celebrities, artists, and brands.
Layer-2 solutions are technologies that aim to improve the scalability and performance of blockchain networks by moving some transactions or computations off-chain. Layer-2 solutions can reduce congestion, fees, and latency on the main chain, while preserving its security and decentralization. Layer-2 solutions are especially relevant for Ethereum, which is facing bottlenecks due to its high demand and limited capacity.
Interoperability protocols are technologies that enable communication and interaction between different blockchain networks or systems. Interoperability protocols can enhance the compatibility, efficiency, and diversity of the crypto ecosystem, by allowing users to transfer value and information across various platforms and applications.
CBDCs are digital currencies that are issued and backed by central banks. CBDCs are designed to complement or replace existing forms of money, such as cash or bank deposits. CBDCs can offer advantages such as faster, cheaper, and more secure transactions, as well as greater financial inclusion and monetary policy effectiveness. CBDCs are being explored or developed by many central banks around the world, such as China, Sweden, and the Bahamas.
Our portfolio manager is optimistic about the technological innovation that is happening in the crypto industry. He believes that these innovations will create new opportunities and value for both investors and businesses in the crypto space. He also believes that these innovations will drive the adoption and growth of the crypto industry in the long term, as they address some of the key challenges and limitations of the current system.
The crypto market is going through a challenging period, as it faces various headwinds from regulation, environment, and market sentiment. However, the crypto industry is also undergoing rapid innovation and development, as it strives to improve its functionality, scalability, usability, and diversity. Our portfolio manager believes that these innovations will ultimately outweigh the challenges and lead to a brighter future for the crypto industry. He also believes that investors who have a long-term perspective and a diversified exposure to the digital assets’ ecosystem will be well-positioned to benefit from this future.