Every Single Detail You Need To Know About Crypto Contagion

One of the worst years ever for the digital asset sector has just passed. The crypto winter, which began in the first few months of 2022, is still going strong and has worsened recently. According to experts, this is the exact result of the “crypto contagion” that has caused the market to crash and caused investors to suffer even more.

When a significant organization collapses, such as the bitcoin exchange FTX, it brings other organizations down. This phenomenon, or the tendency of a financial crisis to spread to other institutions, markets, and countries, is known as contagion in finance.

What Is Crypto Contagion?

Crypto contagion is a phenomenon that occurs when the difficulties or failures of one cryptocurrency can negatively affect the value or performance of other cryptocurrencies. This can happen when there is a market crash or when there is negative news or events surrounding a particular cryptocurrency.

The term “contagion” describes the transmission of disease through close contact. In the field of finance, the term “contagion” describes a domino effect in which a financial crisis can spread throughout an ecosystem, causing severe damage to markets. It can then spread to further markets and geographies.

A prime example of such contagion is the financial crisis of 2008, which triggered the largest global monetary crisis since the Great Depression.

How Crypto Contagion Affects The Cryptocurrency Market?

First, it is important to understand the basics of cryptocurrencies. A cryptocurrency is a digital asset that uses cryptography for secure financial transactions. Cryptocurrencies are decentralized, meaning that they are not controlled by any central authority such as a government or financial institution. Instead, they rely on a decentralized network of computers to verify and record transactions. Bitcoin is the most well-known and widely-used cryptocurrency, but there are thousands of other cryptocurrencies in existence.

One key factor that can contribute to crypto contagion is the high level of interdependence between different cryptocurrencies. Many cryptocurrencies are built on top of the same underlying technology, such as the blockchain. This means that if there is a problem with the technology, it can affect multiple cryptocurrencies at the same time. Additionally, many investors and traders hold portfolios of various cryptocurrencies, so if one cryptocurrency experiences a downturn, it can have a ripple effect on the value of other cryptocurrencies in the portfolio.

Another factor that can contribute to crypto contagion is the relatively high level of volatility in the cryptocurrency market. Cryptocurrencies are known for their volatility, with prices fluctuating significantly over short periods of time. This can make them risky investments, and when there is negative news or events surrounding a particular cryptocurrency, it can lead to a sell-off and a decrease in value. This can then have a domino effect on other cryptocurrencies, as investors may decide to sell off their holdings in other cryptocurrencies as well.

It is worth noting that crypto contagion can also work in the opposite direction, with positive events or news surrounding one cryptocurrency leading to an increase in the value of other cryptocurrencies. For example, the adoption of Bitcoin by major companies and institutions has led to an increase in its value, which has had a positive impact on the value of other cryptocurrencies as well.

Crypto Contagion In The Past

There have been several instances of crypto contagion in the past. One example is the market crash of 2018 when the value of Bitcoin and other cryptocurrencies plummeted after a period of rapid growth. The crash was caused by a combination of factors, including regulatory uncertainty, hacking, and market manipulation. The crash had a negative impact on the value of other cryptocurrencies, as investors sold off their holdings in the face of declining prices.

Another example of crypto contagion occurred in 2019 when there was negative news surrounding the cryptocurrency Tether. Tether is a cryptocurrency that is pegged to the value of the US dollar, and it is widely used as a stablecoin on cryptocurrency exchanges. However, there were concerns about the company behind Tether, as well as questions about its reserves and whether it was fully backed by US dollars. This led to a sell-off of Tether and a decrease in its value, which had a negative impact on the value of other cryptocurrencies as well.

Terra (LUNA) Collapse

A significant amount of UST was dumped on Anchor Protocol on May 7, 2022, which led to the loss of the stablecoin against the US Dollar. The resulting intense FUD resulted in investors rushing to sell their UST properties. The sell-off caused the UST price to drop to around $0.35 in a few days. This had an immediate effect on the price of Luna, which fell 96% within a week and is currently marketed as Terra Classic.

In the end, the $48 billion market valuation of LUNA and UST disappeared together within a short period of time. Therefore, the financial records of any businesses that invested in Luna and the UST were heavily lacking. This had a significant knock-on effect, causing some businesses to stop evacuations, fire personnel, and even file for bankruptcy. Following the Terra crash, several notable businesses went bankrupt, including crypto hedge fund 3 Arrows Capital (3AC), brokerage Voyager Digital, and crypto lenders Would and Celsius.

Fall Of FTX

The demise of Terra resulted in a drop in the price of the cryptocurrency, which put pressure on the entire ecosystem of digital assets. The FTX disaster dealt another devastating blow to the market just as it was starting to recover. The second largest cryptocurrency exchange in the world, FTX, filed for Chapter 11 bankruptcy on November 11, 2022, due to severe liquidity issues. However, the crypto market was unprepared for the collapse of FTX, and the sector was caught off guard.

The transition caused by the collapse of FTX resulted in a huge hole in the bearish market. Since most of their assets were deposited on the FTX, hundreds of companies that were vulnerable to the exchange experienced liquidity issues. Withdrawals were blocked by well-known crypto firms such as Blockfi, Genesis Capital, Gemini, and others. BlockFi had to declare bankruptcy before taking legal action against FTX.

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