Lessons From the Crypto Market Pullback 

Kim Grauer, head of research at Chainalysis, writes in the PYMNTS eBook “Baseline 2022: What the Next Six Months Holds” that the crypto industry has an opportunity to leverage blockchains’ transparency to analyze systemic risk, build better systems, and design better rules for the next bull market.

We’re in a bear market across financial assets. But why have cryptocurrencies, which are now more correlated to tech stocks than ever before, experienced a more extreme price crash than equity markets?

One major factor is that decentralized finance (DeFi) has gotten more competitive, driving some entities to execute on riskier investment strategies that can have ripple effects across the ecosystem.

Right now, the industry has an opportunity to leverage blockchains’ transparency to analyze systemic risk, build better systems, and design better rules for the next bull market.

First, how did we get here? The number of DeFi services exploded over the past 2+ years, even as investor dollars waned. Lending platforms — which act as centralized entities — had to promise higher and higher yields to continue their growth. This led them to actively put user funds into riskier investments. In fact, lending protocols’ biggest source of funds became other lending and yield-generating protocols in Q1 this year. So, when asset prices began to drop, the effects cascaded throughout the DeFi ecosystem. Compounded by the broader bear market, DeFi and exchange services suddenly saw huge inflows of cryptocurrency as people cashed out their funds or needed to pay back loans or avoid liquidations.

The good news is that crypto’s inherent transparency is quickly bringing some of the inherent risks of DeFi into the spotlight. This makes it possible for regulators, lawmakers, and the industry overall to more efficiently and effectively understand what happened and take action to ensure the ecosystem grows more safely and responsibly.

In the near term, I expect some projects that were hastily built or services that didn’t properly manage risk will fail. After all, that’s a natural process for any new technology or industry. But I predict that crypto will be remarkably resilient, thanks to the fast feedback loops afforded by its transparency, and will come back stronger than before.