Multiple analyses: What are the reasons behind the cryptocurrency market crash and the Terra ecosystem going out of control? What is the outlook for the future?

Editor: Colin Wu, Wu Says Blockchain

Blofin Macro and Options Trader Griffin

There is no doubt that the current cryptocurrency market seems to be out of control. With multiple factors such as the de-pegging of UST, the sharp decline in U.S. stocks, and net selling by cryptocurrency investors reaching a new high for the year, the volatility of cryptocurrency assets represented by BTC has risen to its highest level since the beginning of the year. From the skew data, the short-term risk aversion sentiment in the entire market has also reached a yearly high, with investors buying a large number of put options to hedge against potential further declines.

Another more dangerous signal is that the premiums on long-term futures of mainstream cryptocurrency assets have significantly fallen below the risk-free rate of return. In this case, the expected returns for cryptocurrency investors have dropped below risk-free returns, and more investors may further turn to risk-free assets, making it difficult for the liquidity of cryptocurrency assets to improve in the short term.

However, we are also seeing some signals that the market chaos may be coming to an end. The largest negative gamma exposure in the history of the cryptocurrency market has been preliminarily controlled, with a significant narrowing of negative gamma exposure for ETH. The changes in gamma exposure indicate that market makers and investors are beginning to have the ability to "correct" the current trend of market inefficiency, but before the strong negative gamma exposure looks likely to continue to exist before Friday's derivatives settlement, this means sustained high volatility in the market in the short term.

Currently, the U.S. April CPI data to be released on Wednesday will be the focus of reversing the current market situation. If the CPI data is controlled as expected, the likelihood of the Federal Reserve taking more aggressive measures will significantly decrease, and market confidence will also be supported; however, if the CPI data remains out of control, this means that the Federal Reserve's future negative impact on the risk asset market will further intensify. In short, in the medium to short term, it is already very difficult to see the possibility of the cryptocurrency market returning to its highs.

Huobi Research Institute

From a historical perspective, the two rate hikes of 50 basis points in 1994 and 2000 produced different policy effects: the former achieved a soft landing for the U.S. economy, maintaining healthy growth; the latter burst the stock market bubble, leading the U.S. economy into recession.

The success of the 50 basis point rate hike in 1994 was mainly due to two reasons: first, it was a preemptive rate hike; second, the external environment was stable. The failure of the 50 basis point rate hike in 2000 was mainly due to the already high stock market bubble at that time, along with the 9/11 incident in 2001, which shattered the myth of domestic security in the U.S. and undermined market confidence.

Compared to 1994 and 2000, the macroeconomic background in 2022 is turbulent and highly uncertain. U.S. inflation has long been high, and the current rate hike is no longer a preemptive measure like in 1994. Coupled with the impacts of the COVID-19 pandemic and the Russia-Ukraine war, the stock market bubble is also high. Therefore, this rate hike is currently showing catastrophic consequences similar to those in 2000.

BitMEX Founder Arthur Hayes

In a recent article on April 11, BitMEX founder Arthur Hayes predicted that Bitcoin and Ethereum are highly correlated with the Nasdaq 100 index. With the Federal Reserve's interest rate hikes, by June of this year, Bitcoin and Ethereum will test $30,000 and $2,500 (both of which have already fallen below these numbers). He stated that he has purchased put options for June 2022.

Previously, he mentioned that the support levels are $28,500 for Bitcoin and $1,700 for Ethereum. "The market will not bottom out until these levels are retested. If the support levels hold, that would be great; the issue would be resolved. If not, then I believe Bitcoin and Ethereum could drop to $20,000 and $1,300 due to liquidation."

BitMEX Analyst @lasertheend

Right now, people are concerned about two things: one is the de-pegging of UST, and the other is whether LFG will drag the entire market down with it.

I like to compare public chains/projects to countries; each country has its own monetary policy and economic model, just as each public chain has its own ecosystem and monetary model. For Terra, its biggest difference is that, unlike others that settle directly in U.S. dollars, Terra has adopted a "pegged exchange rate system" similar to Hong Kong. The benefit of this is that UST can gain some "Federal Reserve-like" privilege in terms of capital efficiency. The downside is also evident: when the public loses confidence in UST, or when financial sharks discover that its issuance exceeds its economic capacity and can profit from shorting, it faces a fatal de-pegging blow, much like the Argentine peso back in the day. Currently, UST is also facing severe challenges.

From a fundamental perspective, we see that the demand for UST has decreased due to the lowering of Anchor's interest rates, and there is currently no second "killer app" to attract more UST inflow. This has led to doubts about whether UST is being "over-issued." In the short term, the de-pegging of UST is mainly due to large holders fleeing from Anchor -> UST under pressure -> poor overall market -> LUNA dropping further. This cumulative butterfly effect has led to a slow death spiral.

As for whether the de-pegging of UST will trigger a market crash, it is important to pay attention to whether LFG will continue to increase loans to market makers for BTC, as the on-chain arbitrage mechanism of LFG has not yet been completed. Recent loan activities can be understood as LFG providing market makers with risk-free arbitrage opportunities. Market makers can sell Bitcoin -> exchange for USD -> buy UST -> and when UST restores its peg, use UST to buy back Bitcoin. Because even if Bitcoin sells off, they can still use borrowed UST to buy back Bitcoin. This somewhat illustrates the level of desperation of LFG.

The most terrifying thing is not that LFG sold $2 billion worth of Bitcoin and faced a crash, but that the continuous de-pegging of UST will destroy confidence in the entire market, and the loss of confidence in Terra will spread to the entire market and traditional institutions investing in cryptocurrencies.

Researcher Winter Soldier

The recent situation has many similarities to 2018. From a macro perspective, when the nest is overturned, how can the eggs survive? The sharp decline in U.S. stocks back then was an important trigger for the cryptocurrency market entering a harsh winter at the end of 2018. Now, a similar structure has reappeared, and the entire financial market's bubble is accelerating its collapse, leaving cryptocurrencies no exception.

Additionally, the current market decline is compounded by some of its own factors, such as the bursting of the DeFi bubble. DeFi was the engine of this bull market, but it is somewhat like the various derivatives that triggered the 2008 financial crisis; it is an amplifier that can magnify both profits and risks. When the market is in decline, any collapse at a single point in the complex nested chains of DeFi can potentially trigger systemic risks. Especially for some projects that claim to offer "risk-free arbitrage" or "free riding," they often attract massive amounts of capital, but the risks are actually very high.

Finally, I would like to briefly share my views on the UST incident. After all, the market generally believes that the collapse of UST is the direct cause of the market decline, and UST's future fate will also influence the overall market trend. Personally, it is also very difficult to judge whether UST can survive this time. On the positive side, the current decline can be seen as a stress test for UST. If we compare UST to USDT back in the day, USDT has actually experienced multiple trust crises. In extreme situations where the exchange rate dropped by 20-40%, USDT went through similar experiences but managed to recover without major issues. It is precisely because it passed those stress tests that today's market generally accepts and trusts USDT.

The current trials are a necessary baptism on UST's path to becoming a deity. Of course, on the negative side, UST is still an algorithmic stablecoin, and previous algorithmic stablecoins have not ended well; UST is very likely not to become the only successful exception.