Crypto contagion deters investors in near term, but fundamentals stay strong

The past six-odd months have been nothing short of a financial soap opera for the cryptocurrency market, with more drama seemingly unfolding every other day. To this point, since the start of May, a growing number of major crypto entities have been tumbling like dominoes, with the trend likely to continue in the near term.

The contagion, for the lack of a better word, was sparked by the collapse of the Terra ecosystem back in May, wherein the project’s associated digital currencies became worthless almost overnight. Following the event, crypto lending platform Celsius faced bankruptcy. Then Zipmex, a Singapore-based cryptocurrency exchange, froze all customer withdrawals, a move that was mirrored by crypto financial service provider Babel Finance late last month.

It is worth noting that since December 2021, nearly $2 trillion has been wiped out from the digital asset industry. And, while markets across the board — including equities and commodities — have been severely affected by the prevailing macro-economic climate, the above-stated slew of collapses have definitely had a role to play in the ongoing crypto drain. To this point, Ben Caselin, head of research and strategy for crypto exchange AAX, told Cointelegraph:

“The contagion has played a big part in the recent downturn, but we cannot ignore the wider market conditions and the change in fiscal policy as important factors playing into price. The situation concerning Celsius, Three Arrows Capital but also Terra is expressive of an over-leveraged system unable to withstand severe market stress. This should in the least serve as a wake-up call for the industry.”

He went on to add that increasing mass adoption of digital currencies in the future should be done by expanding the scope of crypto beyond its prevailing “sound money narrative.” Caselin highlighted that the market as a whole now needs to take into account and implement financial practices that are sound and sustainable in the long run.

What do the recent insolvencies mean for the industry?

Felix Xu, CEO of decentralized finance (DeFi) project Bella Protocol and co-founder of ZX Squared Capital, told Cointelegraph that the past month has been a “Lehman moment” of sorts for the crypto market. For the first time in history, this industry has witnessed the insolvency of major asset managers such as Celsius, Voyager and Babel Finance within a matter of months.

According to his personal research data, while ailing projects like Voyager and Genesis collapsed due to the fact that they had the most exposure to Three Arrows Capital (3AC), the collapse of 3AC, Celsius and Babel Finance emanated due to rogue management practices associated with the assets of their users. Xu added:

“I believe the first wave of forced liquidation and panic selling is now over. As asset managers and funds file for bankruptcies, their crypto collaterals will take a long time to be liquidated. On the other hand, DeFi lending platforms such as MakerDAO, Aave and Compound Finance performed well during this downturn, as they are over-collateralized with strict liquidation rules written into their smart contracts.”

Going forward, he believes that the crypto market is likely to move in correlation with other asset classes including equities, with the industry potentially taking some time to rebuild its lost investor confidence. That said, in Xu’s opinion, what happened last month with the crypto market is nothing new when it comes to the traditional finance space. “We’ve seen it in the 2008 financial crisis and the 1997 Asian financial crisis,” he pointed out.

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Hatu Sheikh, co-founder of DAO Maker — a growth technologies provider for nascent and growing crypto startups — told Cointelegraph that the aftermath of this contagion has been strongly negative but not for the reason many people would imagine: