When the curtain closes on 2021, it'll go down as another solid year for the stock market. Through Dec. 13, the benchmark S&P 500 had more than doubled (+24%) its average annual total return of 11% over the previous four decades.
But for cryptocurrencies, things haven't been good -- they've been outstanding. Since the year began, the aggregate value of digital currencies has increased by 176% to $2.14 trillion. Investors have been driven by the excitement surrounding decentralized applications and decentralized finance (DeFi), the rise of non-fungible tokens (NFTs), and the mammoth potential for blockchain-based gaming in the metaverse. And let's face it, cryptocurrencies are also chasing life-altering gains, such as the more than 45,000,000% year-to-date increase in meme-coin Shiba Inu (SHIB 0.35%).
However, the upcoming year may not treat digital currencies as kindly. What follows are five reasons cryptocurrencies, as a whole, could crash in 2022.
Image source: Getty Images.
1. History suggests reversions are commonplace
To begin with, history suggests that the crypto market is in trouble. Even though big upswings have occurred frequently over the past decade, reversions following these upswings are commonplace, too.
Since the March 2020 bottom, the total value of all digital currencies has jumped more than 14-fold to $2.14 trillion. This is somewhat similar to the 35-fold increase in total market value over roughly 10 months between March 2017 and January 2018. However, following the January 2018 spike, the aggregate value of all cryptocurrencies would go on to decline by just shy of 90% over the subsequent 11 months.
We've witnessed similar reversions in individual cryptos that delivered life-altering gains, as well. Popular tokens like Nano, XRP, and Litecoin produced peak short-term gains ranging from 24,000% to nearly 462,000%. All went on to lose 93% to 99% of their value in a 12-month to 26-month stretch.
The point is this: Trading euphoria always retraces in a big way in the cryptocurrency space.
Image source: Getty Images.
2. Blockchain euphoria outpaces its use case
People have every right to be excited about the future potential for blockchain technology. DeFi offers the possibility of making almost instantaneous cross-border payments at low cost and can democratize the process to ensure even emerging-market residents can take part. There are also smart contract-based blockchains that can revolutionize supply chains.
But if there's one constant with every single next-big-thing technology, it's that investors always -- and I mean always -- overestimate how quickly a new technology or service will be adopted. We've watched it happen with the advent of the internet, business-to-business commerce, genomics, 3D printing, and now, blockchain technology.
While blockchain is exciting, it's simply not widely adopted yet, nor anywhere close to broad-based adoption. Businesses are unlikely to jump at the chance to support large-scale projects until there's evidence of its real-world effectiveness. Yet we won't get this evidence until businesses welcome blockchain with open arms. It's quite the conundrum/Catch-22 that could stall this monster rally.
Image source: Getty Images.
3. An inability to decouple from the stock market
Another reason cryptocurrencies might crash in 2022 is their inability to decouple from the stock market.
In many ways, digital currencies are viewed as independent assets and a hedge to the broader market. For example, Bitcoin (BTC 0.73%) offers the perception of a limited token supply that's capped at 21 million. With the U.S. money supply soaring, investors view Bitcoin as something of a safe-haven investment that'll help store and grow their wealth -- better than the ever-diluted U.S. dollar, at least.
The problem is that cryptocurrencies haven't held up well when the stock market undergoes crashes or corrections. During the fourth quarter of 2018, the S&P 500 approached bear market territory (a decline of 20%). Meanwhile, the aggregate value of cryptocurrencies plunged from around $222 billion to roughly $130 billion over the same stretch (a 41% drop). The crypto market was also pummeled during the five-week coronavirus crash in February and March 2020.
I offer this warning because there are a growing number of clues to suggest the stock market will crash or undergo a double-digit percentage correction in 2022.
Image source: Getty Images.
4. Margin debt wreaks havoc
Look no further than margin debt for a fourth reason cryptocurrencies could plunge in the upcoming year.
Margin describes the amount of money investors are borrowing with interest to purchase or short-sell securities. In some instances, investors using margin to lever their trades can supercharge their returns. But if the securities being purchased on margin don't move in the expected direction over the short term, the brokerages offering those loans could come calling. They'll either want investors to put up extra capital as collateral or could require/force the sale of assets. This is known as a margin call.
Because the crypto-exchange space is so fragmented, it's not exactly clear how much margin debt is outstanding. But make no mistake about it -- offers to deploy leverage aren't difficult to find.
Earlier this year, it was possible for certain investors to utilize 100 times leverage on their cash position when trading Bitcoin. At such immense leverage, even a 1% or 2% move in Bitcoin (which happens often in the blink of an eye) could lead to a margin call and forced liquidation.
If the music suddenly stops in the cryptocurrency market, margin calls could be right around the corner.
Crypto investors have flocked to Shiba Inu-themed coins in 2021. Image source: Getty Images.
5. Meme coins lose their magic
Last but not least, don't be surprised if the popular "fear of missing out" (FOMO) moves suck the life out of the cryptocurrency market in 2022.
This year, pretty much any coin named after the Japanese Shiba Inu dog breed has been on fire. The aforementioned Shiba Inu has gained more than 45,000,000%, while Dogecoin and Floki Inu are higher by 3,119% and 2,763%, respectively, through Dec. 13.
But these meme coins all share one key trait: They lack anything resembling a competitive advantage.
Shiba Inu may be one of the most-searched digital currencies this year, but social-media hype doesn't translate to real-world appeal or long-term potential. The fact of the matter is that Shiba Inu is an ERC-20 token built on the Ethereum blockchain that's subject to the same high fees and processing lag that often impacts Ethereum's network. Nothing about Shiba Inu (or Dogecoin and Floki Inu, for that matter) suggests it'll be the payment coin of choice by businesses in an increasingly crowded field of blockchain projects.
If the FOMO that's driven investors into meme coins subsides, we could watch crypto euphoria quickly evaporate, as well.
