The bubble may have burst.
NYT (“Cryptocurrencies Melt Down in a ‘Perfect Storm’ of Fear and Panic“):
The price of Bitcoin plunged to its lowest point since 2020. Coinbase, the large cryptocurrency exchange, tanked in value. A cryptocurrency that promoted itself as a stable means of exchange collapsed. And more than $300 billion was wiped out by a crash in cryptocurrency prices since Monday.
The crypto world went into a full meltdown this week in a sell-off that graphically illustrated the risks of the experimental and unregulated digital currencies. Even as celebrities such as Kim Kardashian and tech moguls like Elon Musk have talked up crypto, the accelerating declines of virtual currencies like Bitcoin and Ether show that, in some cases, two years of financial gains can disappear overnight.
The moment of panic amounted to the worst reset in cryptocurrencies since Bitcoin plummeted 80 percent in 2018. But this time, the falling prices have broader impact because more people and institutions hold the currencies. Critics said the collapse was long overdue, while some traders compared the alarm and fear to the start of the 2008 financial crisis.
“This is like the perfect storm,” said Dan Dolev, an analyst who covers crypto companies and financial technology at the Mizuho Group.
During the coronavirus pandemic, people have flooded into virtual currencies, with 16 percent of Americans now owning some, up from 1 percent in 2015, according to a Pew Research Center survey. Big banks like Northern Trust and Bank of America also streamed in, along with hedge funds, some using debt to further juice their crypto bets.
Early investors are still probably in a comfortable position. But the rapid declines this week have been especially acute for investors who bought cryptocurrencies when prices surged last year.
The fall in cryptocurrencies is part of a broader pullback from risky assets, spurred by rising interest rates, inflation and economic uncertainty caused by Russia’s invasion of Ukraine. Those factors have compounded a so-called pandemic hangover that began as life started returning to normal in the United States, hurting the stock prices of companies like Zoom and Netflix that thrived during lockdowns.
But crypto’s decline is more severe than the broader plunge in the stock market. While the S&P 500 is down 18 percent so far this year, Bitcoin’s price has dropped 40 percent in the same period. In the last five days alone, Bitcoin has tumbled 20 percent, compared to a 5 percent decline in the S&P 500.
WSJ (“How More Than $1 Trillion of Crypto Vanished in Just Six Months“):
Traders’ flight from risky investments has halved the price of bitcoin and other cryptocurrencies, wiping out more than $1 trillion worth of digital money since November.
Wild swings are fairly common with cryptocurrencies, but even seasoned investors were left reeling as bitcoin dropped 29% over a seven-day losing streak that just ended as a stablecoin—one part of the crypto world that touted its stability—unexpectedly crashed.
Investors are staring at an inflection point in the financial markets as interest rates rise and inflation rages, and they are responding by selling risky assets.
For crypto, it has been a volatile journey into the depths.
Last year cryptocurrencies were on fire and appeared to gain more legitimacy after years of being considered a fringe, speculative product. Tesla Inc. TSLA -0.82% said it bought $1.5 billion in bitcoin, pushing prices higher. Coinbase Global Inc. COIN 8.90% listed its shares in the first major bitcoin-focused public offering.
In November, bitcoin and ethereum, two of the most popular cryptocurrencies, reached all-time highs. Bitcoin’s value at 5 p.m. on Nov. 9 was $67,802.30; ethereum was worth $4,800. They are now down 58% and 60%, respectively, from those levels.
Cryptocurrencies were falling even before last week, victims of sky-high inflation. Bitcoin and other digital currencies have been talked about as inflation hedges. But the ripple effect has played out differently. Surging inflation is spurring the Federal Reserve to raise interest rates faster, which investors believe will cause a slowdown in economic growth. The result: Investors are unloading risky assets, including cryptocurrencies.
Also exacerbating the losses is that crypto trading, originally an individual-investor game, is now dominated by institutional investors such as hedge funds. Those who have sought diversification in crypto have been caught wrong-footed.
WSJ Editorial Board (“Warnings From the Crypto Crash“):
Well, the party was fun while it lasted. But now the liquidity tidal wave is crashing as it always does when credit conditions tighten. This week’s crypto-currency crash is the first body exposed on the beach, and let’s hope the damage doesn’t spread too far into the financial system and broader economy.
Some $200 billion in crypto assets have blown up in 24 hours, led by the collapse of the so-called stablecoin TerraUSD. The crypto universe used to be small and dominated by Bitcoin enthusiasts, but it has swelled as investors sought higher returns amid negative real interest rates.
Hundreds of crypto currencies have been minted in a flurry of speculation. Anyone can create a virtual currency, market it to investors and use the money as he pleases. While fiat currencies such as the dollar are backed by governments, crypto currencies are backed by faith in their developers. What could go wrong?
Investors found out this week. Stablecoins are supposed to hold a fixed peg and let investors seamlessly trade crypto assets. Some are backed by fiat money, though their inventors don’t always disclose what’s in their reserves. Other stablecoins like TerraUSD are underpinned by algorithms, sometimes linked to another crypto currency—in Terra’s case, the token Luna.
To drum up demand for its currency, Terra’s developers created a “decentralized lending” platform that offered interest rates of up to 20% on deposits. Terra was supposed to hold a $1 value. We were also told before the 2008 financial panic that prime money-market funds wouldn’t break the buck. Then one did.
Despite its supposedly fail-safe algorithm, Terra was backed by nothing more than market confidence. And we’ve learned time and again what happens when investors panic. As investors sold off crypto, Terra’s algorithm broke and its value plunged to 36 cents on Wednesday. What happens to Terra owners? Stay tuned.
One risk is that Terra’s rout causes investors to lose faith in other virtual currencies and creates a market contagion. Crypto currencies are often used as collateral for trading, and other popular tokens are getting pummeled this week. The stablecoin Tether, which is backed by opaque hard currency reserves, wavered from its dollar peg on Wednesday.
Crypto currencies have passionate supporters, and the best may find a permanent place in the financial marketplace. But more than a few will wash out in this liquidity purge. As we learned in 2008, problems on Wall Street can quickly spread to Main Street. The challenge for regulators is to protect the financial system from damage that won’t end with crypto. They’d better be preparing for the next casualties.
While I can’t claim to fully understand cryptocurrencies, I’ve always viewed them with suspicion. Their initial premise, at least as I understood it, was to create a medium of exchange that couldn’t be tracked by government. Which, while one can see the upside even for legitimate transactions, comes with rather obvious downside risks: to the extent it’s invisible to government, there’s no way for the legal system to protect investors from fraud. And, as they have proliferated and their values gone through boom and bust cycles, the whole thing just seemed obviously untethered to anything real, relying on the Greater Fool Theory of investing.
As confident as I am in the existence of fools, that just seemed like a really unwise—not to mention immoral—way to invest. Most of my retirement money is in the market because I’m confident that, in the long run, the American economy will rise. Investing in something that is pays off only if some sucker is left holding the bag is a whole different animal, entirely.