- A risk-averse economic climate, increased regulation, and crypto scams could all threaten the crypto industry in 2022.
- Stablecoins like Tether could also pose a significant threat if they don't have enough cash in reserve to support the tokens issued.
Could these threats cause a crypto ice age?
Even critics would have to admit that 2021 was an extraordinary year for crypto. However, 2022 hasn't got off to the best start. The granddaddy of crypto, Bitcoin (BTC), is down around 40% from its November high and many smaller cryptocurrencies have seen even bigger losses.
Some are already calling the price slump a crypto winter and predicting a prolonged period of depressed prices. It's too early to know, but there are some ongoing threats to the cryptocurrency industry in 2022 that could have a big impact. Here are four that every crypto investor should be aware of:
1. Wider economic conditions
The concept of decentralization -- cutting out the middleman -- is a cornerstone of the crypto industry. Bitcoin was designed to be a digital currency that didn't need a central authority like a government or bank to operate. As a result, the crypto community sometimes falls into the trap of thinking it's immune to what's happening in the rest of the world. The flaw in that logic is that as crypto becomes more mainstream, the wider economy plays a more significant role.
This was brought home by the recent crash. The Federal Reserve's decision to pull back on various pandemic related economic stimulus measures was a major driver behind the slump. The Fed's moves, aimed at tackling rising inflation, caused investors to pull out of higher risk assets, such as cryptocurrency. Tensions between Ukraine and Russia have only added to the global economic uncertainty.
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2. Increased regulation
The specter of increased regulation has been hanging over cryptocurrency for quite some time. Nations around the world are grappling with how to handle this sprawling industry without crippling it. When China cracked down heavily on crypto last May, prices dropped dramatically.
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U.S. authorities have said they don't plan to follow China's example, but lawmakers want to introduce stricter controls. One concern is that some crypto projects offer bank-like services but don't have to follow the same rules as banks. Another is that some cryptocurrency projects have a lot in common with stock investments, without the same reporting and transparency requirements that prevent things like insider trading and market manipulation.
The challenge is that the crypto industry is now worth around $2 trillion. It's increasingly well established and many retail investors have put their money into various crypto projects. In other words, imagine a building that's been constructed on faulty foundations -- for the building to survive and grow, it needs to strengthen those foundations. But doing so could cause the whole structure to collapse.
3. Potential collapse of Tether (USDT) or other stablecoins
Tether is arguably one part of the dodgy foundations I mentioned above. It's certainly a big reason why lawmakers want controls on how stablecoins operate. Concerns over Tether's short-term debt caused Jim Cramer to tell audiences to sell their crypto in October.
Stablecoins are cryptos that peg their value to another commodity such as gold or, in the case of Tether, the U.S. dollar. That means each USDT issued should always be worth $1. Tether is a fiat-backed stablecoin, which means it should have money in reserve to support every token that's issued.
Here's one reason this matters. Let's say you gave $500 to a friend for safekeeping. That friend lends the money to someone else on the promise they'll pay interest, or invests it in crypto. If the friend profits from your cash, they keep the extra money. But if the friend loses the money, you're the one that suffers. This is a big oversimplification, but it illustrates why investors have the right to know what risks Tether is taking with their money.
Tether is the third-largest cryptocurrency with a market capitalization of almost $79 billion. That means it needs $79 billion in reserve to support the USDT in circulation. The problem? According to the New York Attorney General, Letitia James, that hasn't always been the case. "Tether's claims that its virtual currency was fully backed by U.S. dollars at all times was a lie," she said in a press statement. Tether denies any wrongdoing.
Tether's latest report showed that just 10% was held in cash and bank deposits. Almost half is in a type of short-term debt called commercial paper, with the remainder in money market funds and treasury bills. Critics want to know how that commercial paper is allocated and are not convinced Tether would be able to support USDT if there was a run on Tether.
The Treasury wants audits to ensure stablecoins actually have the necessary reserves, as well as increased transparency about how that money is held. What isn't clear is what will happen to the crypto market if Tether can't meet whatever new requirements it introduces.
4. Scams and fraud
Crypto scammers made off with a record $14 billion in cryptocurrency last year, according to crypto analytics company, Chainalysis. And investments tied to cryptocurrencies and digital assets topped the list of investor threats in a survey by the North American Securities Administrators Association.
Criminal activity undermines investor confidence and costs ordinary people money. Moreover, it hampers the increased adoption of cryptocurrency -- it makes institutional investors more wary of getting involved and makes merchants and shoppers less likely to use crypto for payments.
Cryptocurrency has come a long way in recent years, but it still has a long way to go if it's to achieve its full potential. On the one hand, we have legitimate cryptocurrencies that talk about changing the way we use money or changing the way the internet works. On the other, we have billions of dollars lost to scams and crypto crime, and a $79 billion elephant in the room called Tether that few people want to talk about.
Cryptocurrency investors are used to thinking about risk in terms of volatility and their individual investments. But it's important to also see the bigger picture. If some of these industry-wide threats are realized, not only could we sink into a crypto winter, but we may also witness a crypto ice age.
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Emma Newbery owns Bitcoin.
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