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What Is a Recession? Does It Affect Crypto?

Along with inflation, recessions have become a key talking point following the outbreak of the COVID-19 pandemic. Many investors, business leaders, and politicians have expressed different opinions on whether the global economy has entered a recessionary period. 

Although there are varying definitions of a recession, there are some key features analysts use to measure and predict this phase in a country’s business cycle. Learning what a recession is can help you better prepare your portfolio and manage your financial expectations.

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What does recession mean?

Recessions are sustained declines in a nation's economy. In other words, if a country’s overall economic activity is weaker than in previous quarters, it’s entering a recession. 

Not every economist agrees on how to define a recession, but most look to metrics like consumer spending, the labor market, and GDP (gross domestic product) to track the health of an economy. If GDP and spending go down as unemployment increases, there's likely a recession. It's also common for the stock market to plummet and yields on short-term bonds to increase when a recession hits. 

In the U.S., the National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

While recessions are often considered a break in an economy's slow and steady rise, they aren't out of the ordinary. Indeed, many economists believe recessions are unavoidable in a nation's business cycle, which refers to the ebb and flow of growth and contraction every economy goes through. Although economic growth tends to be the normal trajectory, there often comes a point where this growth is unsustainable, and multiple asset bubbles burst. 

What happens in a recession?

Since a recession affects all aspects of a nation's economy, there isn't one cause for this phenomenon. However, there are a few noteworthy signs of a recession: 

  • Decrease in consumer spending and confidence: During a recession, citizens and businesses are more likely to save cash rather than spend. Consumer discretionary sales declines and surveys like the Consumer Confidence Index (CCI) go down. 
  • Rise in unemployment: As more companies struggle to stay afloat, layoffs become increasingly common. It becomes more challenging for people to find job opportunities. These factors often lead to an increase in unemployment claims. 
  • Significant decline in the stock market: Since companies struggle to do business during a recession, they typically report weaker earnings and guidance in their quarterly reports. Investors sell off assets like stocks, mutual funds, and ETFs (exchange-traded funds) in a recessionary environment. 
  • Inverted yield curve for bonds: An inverted yield curve means the cost for short-term bonds is greater than for long-term bonds. Traditionally, the flip from a positive to an inverted yield curve has been a primary indicator of an upcoming recession. When investors are willing to pay a premium for short-term bonds, it suggests there's low confidence in the current state of the economy. 
  • Drop in GDP: GDP measures the overall goods and services a nation produces. During a recession, it's expected that GDP figures will keep falling. Most economists believe two consecutive quarters of decline in industrial production signals a high risk for a recession.  

How long do recessions last? 

Since the Great Depression, most recessions in U.S. history have lasted for about 10 months. However, it's challenging to mark the exact start and end date for every recession. Also, some industries and employees may feel ripple effects from a recession for years afterward. 

Since a recession is a sustained economic downturn, it’ll always last at least a few months. There have been cases where recessions have lasted for years. For instance, the Great Recession following the 2008 financial crisis lasted roughly one year and six months. There were also recessions in the early ‘70s and ‘80s that lasted for more than one year.

Consequences of a recession

Recessions paint a pessimistic picture for investors, employees, and businesses. This negative sentiment profoundly affects consumer psychology, business activity, and government policy. Here are a few major ramifications of a recession:

  • Increased government spending on unemployment services: As more people lose jobs during a recession, governments have to spend more on providing services like unemployment benefits. Often, the U.S. unemployment rate climbs to more than 10% during a recession (e.g., U.S. unemployment hit 13% during the COVID-19 lockdowns in the second quarter of 2020).  
  • Less investment activity: During a recession, investment firms aren’t as willing to put their money to work investing in public stocks or private equity firms. Instead, most investors turn to assets such as bonds or precious metals during a recession. It's also more likely for people to store most of their wealth in cash until they feel confident the recession is over.    
  • Reduced chances of getting loans: Banks tend to increase their cash reserves as more people lose their jobs and businesses go under. It's more likely that financial institutions will raise their standards for taking out a loan. To prevent defaults, banks often increase the collateral requirements and credit scores needed to borrow funds. 
  • Decreased entrepreneurial activity: With few willing investors and steep loan requirements, recessions are a terrible time to start a company. Even if people have the "entrepreneurial spirit," they’ll probably hold off investing in a new business during a recession. 
  • Company reductions in force: As there’s less investment activity and investment, many companies are forced to lay off a part of their workforce during a recession. This obviously means spending decreases even further and potentially leads to an increase in unemployment. 

What is a recession in crypto?

The history of Bitcoin (BTC) dates back to the 2008 Financial Crisis. Indeed, Satoshi Nakamoto was inspired to create Bitcoin in response to the many controversial government bailouts following the collapse of firms like Lehman Brothers.

Although the history of cryptocurrency began during the Great Recession, the blockchain industry was incredibly small at the time. Also, many Web3 innovations like smart contracts, play-to-earn games, and NFTs (non-fungible tokens) didn't exist until Ethereum (ETH) began in 2015. 

The crypto market has grown rapidly since the Great Recession of 2008, but it's unknown how the mature blockchain industry will react to an economic recession. Analysts don’t have enough data on the correlation between macroeconomic factors and crypto prices. 

Although the crypto market hasn't been around as long as the stock market, economists have a few predictions on what a recession means for digital tokens:

  • Crypto values will depreciate during a recession: Most investors believe the prices of cryptocurrencies will go down. Despite the rising adoption of cryptos like Bitcoin and Ethereum (ETH), these coins remain the most volatile, speculative, and risky of any asset class. Unless Bitcoin becomes more established as a global reserve currency, digital assets will likely follow the downward trajectory of most high-growth tech stocks. 
  • Crypto investors will flee to the least risky projects: The money that stays in the crypto market during a recession will likely flow into established projects and stablecoins. Generally, when the crypto market is in a bear trend, Bitcoin's dominance rises as more investors exit speculative small-cap altcoins (or non-Bitcoin cryptos). Traders often use the Bitcoin Dominance Chart to see how much of the total crypto market cap is in BTC.  
  • Layoffs may increase at crypto companies: As the prices of digital assets fall, many companies with crypto exposure will issue layoffs or stop hiring. Following the crypto selloff in 2022, many prominent centralized crypto exchanges (CEXs) like Coinbase, Gemini, and announced they were laying off hundreds of employees. It's also less likely that Web3 start-ups will launch dApps (decentralized applications) as the interest in crypto wanes. 
  • Lower volume and trading activity: In an uncertain economic backdrop, most investors want to stick with "safe bets." Unless retail investors are firm believers in Bitcoin, Ethereum, and other blockchain projects, they’ll concentrate their capital on less volatile assets like bonds. CEXs will likely have lower trading volume during a recession than a bull market

How is an economic recession different from a depression?

Economic depressions share all the traits associated with recessions. However, a depression’s impact is always more severe and widespread. While most economists expect recessions periodically, depressions are extreme scenarios that aren't a part of the standard business cycle. 

For example, during the Great Depression of the ‘30s, unemployment in the U.S. peaked at 25% and production dropped one-third compared to 1929. One of every two U.S. banks went under, and the U.S. stock market declined more than 20% between October 28 and October 29, 1929. 

The panic during a depression is usually more intense and widespread than during a recession. Institutions like the Federal Reserve will likely take drastic measures with fiscal policy and interest rates to relieve an economic depression. 

Wrapping up

Recessions are challenging times, but they’re a natural part of the economic cycle. The better prepared you are for recessions during growth periods, the easier time you'll have to manage your finances. Carefully look at your portfolios and set aside a few months' worth of emergency funds to prepare for recessions. 

Although crypto is still a speculative asset class, at Worldcoin, we believe digital tokens have the potential to address many macroeconomic issues. We feel everyone should have equal access to the cryptocurrency economy, which is why we’re putting a share of our crypto in everyone’s hands for free. We’re also airdropping free DAI tokens to anyone who downloads our app. Subscribe to our YouTube channel to learn more.

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