Bear and bull meme and crypto crashing diagram.

Digital currency crash: What happens next?

Forced liquidations, margin calls, insolvency, companies going out of business—I think that will be the short-term trend in the blockchain and digital asset space.

In a recent interview with Bloomberg, Sam Bankman-Fried, the CEO of FTX, said that:

“There are some third-tier exchanges that are already secretly insolvent. There are companies that are basically too far gone and it’s not practical to backstop them for reasons like a substantial hole in the balance sheet, regulatory issues, or that there is not much of a business left to be saved.”

He also mentioned that more digital currency exchange failures are coming.

Bankman-Fried has been extending revolving lines of credit to struggling businesses, and it is rumored that he is attempting to acquire some of these failing companies. That being said, Bankman-Fried knows a thing or two about the financial health of digital currency businesses and their ability to exist into the future. It is clear that many digital currency businesses are having trouble staying afloat. I think that what we will see next is companies publicly announcing that they are insolvent, financially struggling, deeply in debt, or forced to shut down their businesses.

Why is digital currency down?

The issues surfacing in the digital currency space were bound to happen on a long enough time horizon. However, global macroeconomic conditions catalyzed them. The United States Federal Reserve is tightening monetary policy, raising rates to fight inflation, and actively reducing its balance sheet to correct the U.S. economy, which was running hot. The actions that the Fed has taken put sell pressure on risk assets.

Digital assets, cryptocurrencies, coins, tokens, or whatever you want to call them are at the top of the risk asset list, which makes them one of the first items that institutional and retail investors sell in anticipation of contracting monetary policy. This initial sell-off dragged digital currency prices down, which led to some market participants getting force liquidated and receiving margin calls—it also showed how many players in the space were over-leveraged and operating on margin.

Among these over-leveraged companies operating on margin were Terra and its UST stablecoin and the Three Arrows Capital hedge fund. Now, it is being revealed that the counterparties that worked with each of these entities are financially struggling as well. A good example of this is BlockFi, the company formerly valued at $5 billion, just raised a down round at a $1 billion valuation and was just bought by FTX for $25 million; and Celsius Network, the company that Sam Bankman-Fried’s FTX considered acquiring but ultimately passed because they said there is a $2 billion gap in their balance sheet.

Cases such as Terra’s UST, Three Arrows Capital, Celsius Network, and BlockFi are in the public eye because these are a few of the largest companies in the blockchain and digital currency space. So just think about the smaller companies that are most likely struggling if these giants with a significantly sized network of investors and creditors are having trouble staying afloat.

Recession 2022

The best way to prepare for the further decline in the digital asset markets that is around the corner is to manage risk. There are ways to make investment decisions that reduce the negative impacts the market will have on you if you are on the wrong side of a trade. Selling isn’t evil either, especially if you know that you will be able to buy back at a lower price in the future.

But ultimately, market participants are just going to have to weather the storm. I imagine that there will be bear market rallies throughout this downtrend, but when the news breaks that reveals that companies of every size are in severe financial trouble—or that they are “secretly’ insolvent” like Bankman-Fried claims—I expect the market to go much lower than where it stands today.

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