After a monstrous 2021, the crypto market came crashing down in 2022, entered a crypto winter, and is now dealing with the FTX bankruptcy, which has cast a dark cloud over the industry.

The market was likely due for a correction after rising so quickly in 2021, but I don't know if anyone expected such a sell-off. And with the FTX bankruptcy spreading contagion fears through the industry, investors are seriously rattled.

Can the crypto market bounce back in 2023? No one knows, but here are the most important sector-specific events I'll be watching.

The Federal Reserve

Cryptocurrencies were first created with the intention of sidestepping the government. But in 2023, a lot of what happens to the sector will depend on an independent government agency, the Federal Reserve.

Person looking at computer monitor.

Image source: Getty Images.

The first thing that will be big for crypto, as well as the entire stock market, will be how the Fed moves in regard to interest rates. In 2022, the Fed raised rates aggressively -- from practically zero to inside a range of 4.25% to 4.5%. This has really crushed the market, especially riskier stocks, because it reduces the future value of cash flows. It also makes safer assets like U.S. Treasury bills yield more.

The Fed has made it clear that its rate-hiking campaign isn't over yet and that it expects its benchmark overnight lending rate, the federal funds rate, to peak at 5.1%. So the first thing to watch is whether this happens in the first half of the year. It will largely depend on whether inflation data can keep trending in the right direction and if the Fed sees further evidence of deterioration in the labor market.

The next big thing to watch is whether the Fed will actually cut interest rates next year. The agency has not made any indication of this, but a lot of investors and economists think it's possible, especially if the economy tips into a recession, another big possibility in 2023. A recession slows growth, and often the Fed needs to lower rates to stimulate economic activity.

The last thing involving the Fed that crypto investors should monitor is its continued unwinding of its balance sheet. This involves letting U.S. Treasury bills and mortgage-backed securities run off its balance sheet, which essentially pulls liquidity out of the economy. When the Fed did the opposite in 2020 and 2021, buying bonds and effectively pumping liquidity into the economy, that inflated a lot of assets, including crypto. It will be interesting to see how the Fed's continued unwinding affects the sector.

The FTX debacle

There have been other bankruptcies in the crypto world, and stablecoin meltdowns, but none have rocked the industry like the FTX bankruptcy.

As many now likely know, FTX founder and CEO Sam Bankman-Fried, along with other executives at the company and its sister trading firm Alameda Research, have been charged with wire fraud, money laundering, and campaign finance offenses. FTX allegedly used customer funds to prop up Alameda after the company made a lot of bad investments. 

A lot of other companies had exposure to FTX, and since the large crypto exchange filed for bankruptcy, other crypto firms, like BlockFi, have followed suit. Additionally, crypto firms including Genesis, Galaxy Digital, and Galois Capital have struggled after having significant exposure to FTX.

Other large crypto exchanges, such as Binance and Crypto.com, have experienced mass withdrawals. Customers really don't trust many of the big exchanges after FTX, which was once quite well respected, went belly-up. The big questions in 2023 are how much longer this trend will continue and if there are other big cases of fraud out there.

We need to see things play out

Crypto investors will be laser-focused on the Fed in the first half of the year to get an idea of whether it is satisfied with the direction of inflation and how the Fed will move with interest rate hikes.

The best-case scenario for crypto is that the Fed is almost done and will soon cut rates and create more of a risk-on environment.

Investors will be monitoring the FTX situation, the resulting court proceedings, and which other crypto firms fall victim to the contagion. There might also be stricter regulations to follow in the crypto space, which could be a good or bad thing. Investors need to regain confidence in the sector, but it could take some time, if ever.