Hero to zero: what really happened to crypto in 2022 and how to play it now

As 2022 draws to a close, many crypto investors are nursing losses, while ‘crypto king’ Sam Bankman-Fried is now behind bars. We take a look at what went wrong and some ideas for investing in future.

Although 2022 was a difficult year for stock market investors, it was nothing compared to the agony for crypto investors, many of whom saw their hard-earned wealth evaporate into thin air.

A year ago, it was a very different picture, as skyrocketing prices turned crypto-internet geeks into megastars. Sam Bankman-Fried (pictured), founder of crypto exchange FTX, was on the cover of Forbes. Described as the “crypto king”, he boasted that he slept next to his desk on a beanbag, presumably to keep half an eye on his burgeoning empire.

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Scores of early adopters shared their fairy-tale crypto journeys on social media. If you’d invested £10,000 in Bitcoin in the early days of 2017, you would have seen your wealth balloon to the dizzying heights of £705,987 by November 2021.

But during 2022, the crypto dream turned into a nightmare for many investors as crypto values crashed by 70%: £10,000 invested in Bitcoin in November 2021 slumped to £2,866.

And Bankman-Fried ended the year in jail as his crypto business filed for bankruptcy.

What happened to crypto in 2022?

The slump in crypto values this year mirrored volatility elsewhere in the investing world. Only where stock market values dipped, crypto values plunged. Crypto assets arguably have no inherent value and so are more severely affected by investor sentiment than traditional asset classes.

As the markets began to turn in late 2021 and early 2022, crypto investors rushed to cash out, many fearing a new crypto winter had begun. It soon became clear that crypto would not provide a hedge against rising inflation as many hoped: in fact, crypto values fell further every time the Federal Reserve raised interest rates.

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Bitcoin is down 71% from its height in 2021, compared with 72% for Ethereum and 86% for new-kid-on-the-block Dogecoin. In comparison, the S&P 500 is down a painful, but relatively modest, 19% from its height in 2021.

Other crypto assets have fared even worse this year, the ill-fated coin Luna crashing from $106 (£87) in March 2022 to a few cents in May 2022, before climbing back up to $1.32 by December: investors lost an estimated $60 billion.

As the year progressed, several crypto exchanges either stopped customer withdrawals or filed for bankruptcy, as investors saw their savings go up in smoke: these exchanges included Genesis, Three Arrows Capital, Alameda Research, Voyager Digital, BlockFi and Celsius Network, and eventually the big cheese FTX.

The rise and fall of FTX and Sam Bankman-Fried

And as for Sam Bankman-Fried (pictured below), the self-made laid-back crypto billionaire, ended the year behind bars, as officials investigated how an apparently successful company could end up filing for bankruptcy. Investors are rumoured to have lost $1 billion worth of assets and Department of Justice charges are said to include wire fraud, securities fraud, and money laundering.

Securities and Exchange Commission (SEC) chair Gary Gensler released the following comment about the charges: “We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto.”

The FTX exchange had gone from being too big to fail to absolute disaster in a few days. Bankman-Fried is blaming the failure on poor accounting, but there are clearly many questions to answer about what went wrong.

Beyond the hype

The sad demise of many crypto-linked businesses during 2022 is a stark warning of the risks of investing in a largely unregulated industry. In a sector often called the “Wild West” of investing, it’s all too easy for crypto wolves to masquerade as sheep and rob us of our life savings.

Nevertheless, like the dot.com bubble, it’s also possible that something of value will emerge from the crypto wreckage of 2022. There are already signs that many governments are considering using digital currency themselves as part of the established economy in the future.

In May this year, Rishi Sunak announced plans to introduce cryptocurrencies, known as stable coins, as a form of payment in Britain, and other world leaders have announced similar plans.

Any widespread shift towards government digital currencies could mean a further shake-up of the crypto landscape but could also lead to a glowing future for the blockchain technology behind crypto. It may be that the blockchain technology that supports crypto is worth more than the crypto assets themselves in the years ahead.

Understanding risk

Although there’s nothing wrong in taking some calculated investing risks, it’s important to understand the risk profile of investments and to quote the Sage of Omaha, Warren Buffett: “never invest in a business you cannot understand”.

Knowingly investing perhaps 5% of a large portfolio in risky asset classes is very different to investing your whole life savings and hoping to make your fortune.

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And crypto assets still have well-known advocates. Pershing Square Holdings (LSE:PSH)’s Bill Ackman revealed his support for cryptocurrency via a thread on Twitter, saying: “I have come to believe that crypto can enable the formation of useful businesses and technologies that heretofore could not be created”.

The investments only represent less than 2% of his assets - “I invest more as a hobbyist trying to learn than as a careful investor...I think crypto is here to stay and with proper oversight and regulation, it has the potential to greatly benefit society and grow the global economy.”

If you’ve already invested in crypto assets and are sitting on losses, then it’s a tricky decision whether to hold on and hope that the market recovers, or to cut your losses and sell up. There are certainly no easy answers.

Moving forward, if you do want to dabble in crypto investing then it’s important only to invest what you can afford to lose and to make sure your portfolio is well diversified.

How to invest in crypto

One alternative to buying directly is to invest in an investment trust or fund that already has crypto or blockchain exposure.

RIT Capital Partners (LSE:RCP) has positions in several blockchain and crypto businesses including Paxos (0.6% of net asset at 30 June); Kraken (0.5% of net assets at 30 June) and Webull (1.2% of net assets at 30 June).

Investment analyst Numis says that “RIT’s approach to blockchain is based upon careful diligence, leveraging their network to identify the best-in-class businesses and entrepreneurs, and the focus remains on real businesses with real profits, not in cryptocurrencies directly."

Scottish Mortgage (LSE:SMT) has positions in crypto exchange platform Blockchain.com (0.8% of total assets at 30 September)and Blockstream (0.5%), which seeks to build crypto-financial infrastructure based on Bitcoin.

Blockstream is also held by Baillie Gifford US Growth (LSE:USA) (0.4%) and Schiehallion. Edinburgh Worldwide (LSE:EWI) has a position in Lightning Labs (0.6% of total assets).

Numis said: “It is interesting to see the varied views and growing exposures to cryptocurrencies in the investment companies sector. We expect it to continue to polarise views for some time. It is interesting to note the exposures via exchanges/platforms, which are generally considered lower risk than direct cryptocurrency exposure, although not without risk as highlighted by the FTX collapse. We expect that a significant tipping point to be when bitcoin/cryptocurrencies can be used more effectively on a transactional basis and these mechanisms appear [to be] developing.”

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Another alternative to investing directly in crypto assets is to invest through a blockchain exchange-traded fund (ETF), that spreads risk across many currencies and businesses. However, just like their individual components, performance has been dismal during 2022.

VanEck Crypto& Blockchain Innovtr ETF has returned minus 83% this year since January; Invesco CoinShares Global Blockchain ETF has returned minus 47%, while ETC Grp Dgtl Assts & Blckchn Eq ETF has returned a depressing minus 73%.