The Luna Contagion:

Digital currencies, since they first emerged in 2008, have seen many developments, from achieving unbelievable profits and sudden losses for investors to many businessmen and investors warning against approaching those currencies. Then came the Russian-Ukrainian crisis, causing more volatility in global markets, including the cryptocurrency market. With the beginning of military intervention in Ukraine, digital currencies have played a pivotal role. The two sides have employed cryptocurrencies for various reasons and in multiple ways, driving a rise in digital currencies. But after that, they underwent a marked decline that turned investors’ attention to the need to beware of digital currencies, especially given the wave of stagflation sweeping the world and the US Federal Reserve raising interest rates.

Decline in Value

The emergence of cryptocurrencies dates back to 2008, when a mysterious person calling himself "Satoshi Nakamoto" created Bitcoin. The digital currency was portrayed as a decentralized alternative to the traditional financial system. The first trading platforms for these currencies launched in 2013. Over time, the digital currency market successfully attracted a large portion of investment liquidity. It also gained large popularity among individual and institutional investors alike with the onset of the COVID-19 pandemic. This momentum continued during 2020 and 2021, until the Russian-Ukrainian crisis came and boosted the profits of these currencies. However, they began to see a decline in recent months.

Many cryptocurrencies have declined markedly. For example, the Terra Luna digital currency fell from $118 in April to $0.09 in mid-May, a drop that indirectly impacted TerraUSD, a currency tied to the dollar which is usually stable. Bitcoin (the first-ranked digital currency in terms of market value) also declined 50% since its peak last November. Ethereum (the second most important digital currency in the world) fell by 10% in mid-May 2022. The total market value of all digital currencies is currently reported to be about $1.12 trillion, around a third of their value last November. This decline is linked to a number of key factors:

1. Adverse consequences of increasing US interest rates: With the beginning of the Russian-Ukrainian crisis—and despite global economic losses resulting from it—the digital currency market managed to achieve record gains of about $600 billion during March. But when the US Federal Reserve decided to raise US interest rates to combat inflationary pressures, the price of digital currencies began to fall. The rise in interest rates has stopped individual and institutional investors from thinking about the cryptocurrency market’s prospects.

The most important cryptocurrencies have seen a marked decline following the US interest rate hike. Bitcoin’s price fell below $30,000 for the first time since last January after the US interest rate rose by half a percentage point, to between 0.75% and 1%, prompting investors to invest in US bonds.

2. Initial concerns about government attitudes: Attempts by some countries to formally regulate the digital currency market have recently increased. This may have negatively affected these currencies, at least in the short term. It is possible that these attempts have raised fears for those dealing in digital currencies. For example, China has intensified its attempts to regulate digital currency transactions. US President Joe Biden also signed an executive order in March to launch a digital currency linked to the US banking system and establish controls for cryptocurrency market transactions. These measures are likely to have reinforced the concerns held by those participating in the digital currency market, especially as the final contours of governments’ regulatory actions in this regard are not yet clear.

3. Implications of the global economic crisis: The decline of cryptocurrencies is part of a broader retreat from high-risk assets, driven by increased interest rates, inflation, and economic uncertainty caused by Russia’s invasion of Ukraine. These factors exacerbated what is known as the pandemic remnants, which began as life returned to normal in the US, harming the prices of companies such as Zoom and Netflix, which flourished during lockdowns.

4. The effect of panics: This term refers to a series of consecutive market repercussions arising from some event, or what we can call a "withdrawal contagion." The decline of one currency, such as Terra Luna or TerraUSD, catalyzed a panic in the transaction market, prompting a clear decline in almost all digital currencies. Economist Frances Coppola told the BBC on May 13 that "the collapse of TerraUSD has started what we used to call ‘the panics,’ when major financial institutions sold off larger chunks of assets and everyone else tried to take their money out as quickly as they could."

According to a May 30 report by Oxford Analytica, "the collapse of the stablecoin Terra USD" caused a decline in the value of cryptocurrencies, along with other guaranteed stablecoins. Current global price volatility is clearly leading to a decline in investor confidence in cryptocurrencies, which are considered a store of value.

5. Anticipating the repercussions of the rise of government digital currencies: The current decline taking place in traditional digital currencies cannot be separated from efforts by some governments to promote their own digital currencies. There is a state of cautious anticipation of the repercussions of the rise of these digital currencies. Some reports suggest that the current digital currency turmoil will increase the US Federal Reserve’s concerns about the degree of stability of traditional digital currencies. This could bolster US plans to develop the digital dollar as an alternative. These plans are also driven by concerns about China promoting the digital yuan.

Two Possible Scenarios

Previously, many investors considered digital currencies safe havens to resort to in crises. But as tensions between Russia and Ukraine began, it became clear that digital currencies are not safe havens, but rather the opposite. Many investors are now withdrawing their money from the digital currency market and returning to metals, gold, and bonds. Currently, it is difficult to predict the future direction of the currency market in the long term. The most important features of the future digital currency market can be divided into an optimistic scenario of these currencies’ future performance, and another scenario that leans towards predicting a decline of the digital currency market. These scenarios can be explained as follows:

*First Scenario: This scenario, which many consider more likely, assumes that digital currencies are able to recover and be an important investment alternative, especially given attempts by some countries to enter the digital currency market. This scenario is based on a number of main premises:

1. Demonstrating resilience in times of global crisis: Historical experiences reveal the attractiveness of investment in digital currencies in times of global crisis. During the COVID-19 pandemic, there was an influx of investors and individuals to virtual currencies. Some 16% of Americans now own some, up from 1% in 2015. Cryptocurrencies such as Bitcoin and Ethereum already proved they are resilient in 2020, when the interest of investors, individuals, and institutions in digital currencies rose significantly during the pandemic. In 2021, the cryptocurrency market flourished and matured. Bitcoin was able to achieve a 59.8% increase in its returns compared to 2020. In total, the combined market value of digital currencies was more than $3 trillion in mid-November 2021, compared to about $620 billion in 2017.

2. Using digital currencies as a tool for support: Digital currencies have become an important tool for obtaining support and assistance in recent years, as may be clear from the Ukrainian model. Ukraine was ranked first in the use of digital currencies in 2020. After the war with Russia broke out, the Ukrainian government used digital currencies to receive donations from countries and global institutions. Ukraine was able, through the government’s official Twitter accounts, to receive donations in digital currency. In April, it was estimated that Ukraine had managed to raise more than $100 million in digital currency donations.

3. The Russian economy may boost the status of digital currencies: Since the beginning of the year, digital currencies in Russia faced a set of difficult obstacles from the government.Most recently, the Central Bank of Russia proposed, at the end of January, to ban the use and mining of cryptocurrencies. Russia is one of the world’s leading bitcoin mining sites, and any move by the central bank would cause violent changes in the cryptocurrency market.

But Russia’s stance on digital currencies soon changed, after the West and the US imposed more economic sanctions on Moscow following its military intervention in Ukraine. The Russian government has worked to develop a digital currency for its central bank, the so-called digital ruble, which it hopes to use to trade directly with other countries wishing to accept it without first converting it into dollars. These technologies could help Russian actors make up for lost revenue. Companies will be able to trade with Russian entities without disclosure, while Russian entities will be able to conduct transactions outside the international banking system with any country wishing to trade in digital currency.

As a result, the US Department of the Treasury has warned that cryptocurrencies pose an increasingly serious threat to the sanctions program, arguing that authorities need to educate themselves about the technology. US government officials are increasingly aware of the potential for cryptocurrencies to reduce the impact of sanctions.

4. Countries develop legislative frameworks to regulate transactions: With digital currencies gaining more popularity over the past few years and making profits—despite recent declines, investors in those currencies have not experienced any losses for years—digital currencies continue to be targeted by many. As a result, many states are seeking to implement legislative frameworks for those currencies. For example, Turkey recently drafted new legislation aimed at tightening control over the cryptocurrency market, with the possibility of imposing taxes on some transactions involving digital assets, according to two official sources. Tanzania’s central bank is also close to launching its own digital currency to help counter the rising popularity of cryptocurrencies in the country.

It is true that some countries moving to implement some controls on digital currency has contributed, one way or another, to some of the recent tremors and fluctuation in the digital currency market. But this impact remains a temporary one in the short term, given the state of fear gripping digital currency users. Thus, the digital currency market is expected to see further stability and recovery after formal regulatory procedures are finalized.

5. Long-term resilience of digital currencies: If government entities put a legal framework and tax system in place for digital currencies, many retailers are likely to start accepting digital currency payments. The increased use of cryptocurrency should spur regulatory agencies to take those measures. Although digital currencies have seen a significant decline in value recently, analysts estimate that the global cryptocurrency market will triple by 2030, reaching a valuation of nearly $5 billion. Investors cannot ignore the wide spread of cryptocurrencies in recent years.

*Second Scenario: This scenario assumes that digital currencies continue to decline in light of current indicators, which have shown a decline of trust in digital currencies and worry about investing in these currencies from many dealers in the market. On one hand, many experts expect digital currencies to continue to decline in the short term, especially with the US Federal Bank raising interest rates. It thus put an end to an era of speculation. Investors have shied away from high-risk investments, given that the Federal Bank raised interest rates as many as six times in 2022 in an attempt to rein in inflation levels that are at a 40-year high. Many investors are also now turning to lower-risk assets, such as gold and silver, at the expense of investment in digital currencies.

On the other hand, the issue of environmental damage raises questions about the future of these currencies. The cryptocurrency industry is not in line with global goals for a transition to clean energy. Cryptocurrencies are considered a major source of environmental pollution. It is likely the world would need to plant around 300 million trees to make up for digital currency’s carbon footprint. Bitcoin is the worst polluter, followed by Ethereum. Some 75% of Bitcoin is mined in China, especially in rural areas. Around 67% of the electricity consumed in China comes from coal, meaning that most of the electricity consumed for this purpose comes from sources harmful to the environment.

The higher the price of Bitcoin, the higher the amount of energy consumed, and the greater the environmental pollution and carbon emissions that accelerate global warming. For that reason, the state of New York has introduced a bill to ban cryptocurrency mining until the extent of its impact on the environment is established, a project that will take three years. Scientific studies published in 2018 found that mining one dollar’s worth of Bitcoin consumes 4.7 kilowatts of energy, or more than double the amount of energy needed to mine one dollar of copper, gold, or platinum.

Digital currencies continue to gain popularity as a tool for transactions, and there is likely to be a further expansion of the use of these currencies in the future. Many experts and specialists believe that these currencies may become an alternative to paper currencies, provided that the regulation process and legislative frameworks are available for them, that they are subject to state tax systems, and that they shift from the current individual transactions into the institutional system and enter the global financial system. Still, these currencies remain fraught with more risks, so it is not easy to predict their performance.