Ethereum’s Eroding Enchantment: Crypto Crash and Regulatory Crackdown Fuel

Ethereum, alongside Bitcoin and other cryptocurrencies, experienced a record plunge in value amidst the first bearish market for crypto of 2022. The recent downturn caused over $1.4 trillion in global crypto market capitalization to evaporate. While Ethereum’s gradual shrinkage began in late-December 2021 — a month after its price reached an all-time high (around $4,800) — the decline took a sharp, downward turn last Monday as its price fell below $2,200, down 49 percent from its peak and the lowest value since July 2021.

The lagging price immediately follows investor uncertainty over the economic ramifications of the December 2021 Federal Reserve meeting. Minutes signaled an inclination towards more aggressive policy action, including an imminent rate hike in March, as part of the ongoing attempt to control inflation rates and end pandemic financial support. A tightening grip on financing conditions and looming interest rates shift market sentiment towards less volatile options, omitting speculative assets such as Ethereum. The central bank’s narrowing of monetary policy also saw crypto prices dip in tandem with the stock market. The broad-based S&P 500, for instance, fell by nine percent within the same timeframe. All told, crypto finds itself increasingly representative of the macroeconomic environment, diverging from its marketed appeal as a sound inflation hedge.

“It’s possible that macroeconomic concerns, such as the Fed’s response to inflation rates, have facilitated more de-risking activity in general,” said Juthica Chou, head of OTC options trading at Kraken. “The recent price drop, coupled with high volatility, could be leading to further selling as participants look to reduce risk.”

As investors react with cynicism and fluster over the cratering prices of the aforementioned “riskier” assets, Washington feels more pressure to enact new preventative measures as a means of better regulating such volatile market shifts.

“The White House wants to send the clear message that it is fostering a coordinated approach related to cryptocurrencies rather than a scattershot approach from the regulatory agencies,” said an anonymous insider to The Washington Post. “They’re going to use the document to set up a framework for different agencies to start working on different assets important to both financial stability and national security.”

Reactions to the plummeting crypto prices were also provided by notable crypto critics, who utilized the crash to expose the dark underbellies of cryptocurrencies — feeding into the narrative that portrays digital assets as a Ponzi scheme. Particularly, Nobel Prize-winning economist Paul Krugman found “uncomfortable parallels” between the recent crypto market crash and the subprime mortgage crisis. He likened crypto investors to low-credit borrowers of the 2000s in their yield to speculative products despite a full awareness of the larger risks.

Krugman said, “there’s growing evidence that the risks of crypto are falling disproportionately on people who don’t know what they are getting into and are poorly positioned to handle the downside.”

In parallel with the national regulatory crackdown and growing investor pessimism, the crypto crash is also attributed to Russia’s proposal for a “ban” on cryptocurrencies. Constituting more than 10 percent of the global hashrate — a speed metric measuring the computing power used to verify transactions on a proof-of-work network — Russia stands as a major hub for the blockchain’s processing power. However, concerns also arise regarding crypto’s threat to financial stability and monetary policies, its implications in illegal activities, and the risk of an energy shortage due to electricity prices. To address these concerns, following China’s footsteps in banning crypto mining and restricting trading, Russia called for stringent regulations on cryptocurrencies in a government report issued January 20.

“We believe it is necessary to prepare a federal law, establishing a ban on the issue and circulation on Russian territory of private digital currencies and also to determine liability for violating this ban,” said the Russian Central Bank.

To an average investor assessing the impact of further crypto regulation from a vigilant White House, hawkish Federal Reserve, and restrictive Russian central bank, the prospects of crypto seem grim. Reasonably, where cryptocurrencies are not immune to macroeconomic forces, the prices, too, must oscillate in accordance with the extremely volatile nature of the market. However, many fervent investors still maintain hope in Ethereum, exhibiting a stalwart faith in its revolutionary technology and platform, which, in their minds, forgives its intensifying price fluctuations. Furthermore, the bullish case for Ethereum anticipates significant upsides once the platform enters phase two, completing its transition from proof-of-work to proof-of-stake, thus providing more efficiency in the development for NFTs, DeFi, and the wider metaverse.

“According to our research, Ethereum could displace many traditional financial services, and its native token, ether, could compete as global money,” said Yassine Elmandjra, blockchain/crypto-asset analyst at ARK Invest. “[Being] the preferred collateral in DeFi and the unit of account in NFT marketplaces, ether has the potential to capture a portion of the $123 trillion in global M2.”

As the outlook of Ethereum remains entangled in a tug-of-war between alarming short-term volatility and an optimistic long-term potential, the cryptocurrency must brace itself for the ensuing months of unpredictability as macroeconomic triggers flood the market. Whether the technology of Ethereum can withstand the surge of regulations and rampant price swings will persist as one of the most salient unknowns amongst investors, its relevancy hanging in the balance.

By: Chloe Bao