Why is crypto crashing and will it recover? Luna and Terra aren't entirely to blame

Cryptocurrencies are making the stock market look stable these days. 

In the past week, the Dow Jones Industrial Average shed over 3% of its value, over 1,000 points. The tech-heavy Nasdaq Composite lost more than 7% of its value and is trading at its lowest level since July 2020. The S&P 500 lost nearly 5%. 

But all three indices opened high

Meanwhile, Bitcoin shed 19% of its value over this week. The cryptocurrency hovered around $28,722 as of 4:48 p.m. EST on Thursday, the lowest level it has been since October 2020. Ethereum is down almost 27% this week.

David Siemer, CEO of digital asset management firm, Wave Financial, said he's spent the last couple of days "talking clients off ledges."

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A lot of the blame for the crypto selloff is being directed at stablecoins, or cryptocurrencies that are pegged to another commodity, often the U.S. dollar. 

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TerraUSD, which is pegged to the dollar so that one of its coins is always equal to a dollar, and luna, which is pegged to TerraUSD, are on the verge of becoming completely worthless. As more holders of TerraUSD are trying to cash out, the Luna Foundation Guard, which backs the Terra ecosystem, is having trouble defending the peg.

But crypto experts USA TODAY spoke with say that's just one piece of the crypto selloff puzzle. 

Recession fears 

After the first-quarter GDP report revealed that the U.S. economy unexpectedly contracted, the likelihood of a recession has increased, according to some economists. 

As the Fed tries to clamp down on inflation by raising interest rates, many leading economists are concerned that the central bank will unintentionally fuel a recession.

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Cryptocurrency is tanking after Luna and Terra weren't able to defend their pegs

"That's probably obvious that it could lead to a crypto recession," said Siemer. 

There also is growing recognition that some of the conjecture associated with cryptocurrency may be unfounded, said Jordan McKee, principal analyst with S&P Global Market Intelligence.

"Just as some investors believe certain stocks are overvalued, this mentality is being mirrored in the crypto market," he said. 

Bitcoin, other cryptos are taking notes from stocks

Still, "what’s bad for stocks is bad for Bitcoin right now and that includes inflation,"  Michael Safai, managing partner at Dexterity Capital.

Last month, the annual inflation rate ticked down slightly from March, but it still hovers at a nearly 40-year high. As investors spend more money on goods and services, they're often left with less to invest which contributes to the stock market selloff.

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"In periods of higher volatility like this one, it’s one of the first assets that a fund manager or institution will sell if they need to lower their risk profile," said Safai. "It’s likely that the recent selloff was beyond the threshold that many of these firms have been comfortable with."

Is now a good time to buy Bitcoin?

Just like stocks, cryptocurrencies "follow a random walk," said David Yermack, the chair of the finance department at New York University’s Stern School of Business. "The fact that they've dropped a lot doesn't mean that they're going to go back up but it doesn't mean they won't go back up either. Flip a coin."

That said, "crypto has gotten big enough that it should probably be a tiny percent, 1% or something, of people's general portfolios," said Yermack.

Siemer of Wave Financial isn't planning to buy more Bitcoin right now because he already owns a lot, he said, "but if I had no Bitcoin I would buy it." He's also encouraging clients to buy more Ethereum since it's trading at an even bigger "discount" than Bitcoin. 

As for what it will take to get Bitcoin and other cryptos to go back up, Safai said it boils down to the overall economic outlook.

"If investors start to feel that the worst of the inflationary turbulence is over and have confidence in stocks again, then this positivity will bleed down into crypto and give it a lift."

"The timing of this, of course, is uncertain. This could be weeks to months. Another ‘crypto winter’ is not out of the question."

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Elisabeth Buchwald is a personal finance and markets correspondent for USA TODAY. You can follow her on Twitter @BuchElisabeth and sign up for our Daily Money newsletter here