Cryptocurrencies: Anatomy of a Carnage

The value of all cryptocurrencies has fallen in recent days. A move that is reminiscent of the darkest hours in bitcoin history in scope, but whose particularities could make it a particularly painful episode for the economy.

Two hundred billion dollars burned in 24 hours, calculated on Thursday, May 12, the site CoinMarketCap, which monitors the evolution of cryptocurrencies. The latter are currently crossing a zone of very strong turbulence, recording repeated losses and seemingly endless.

The queen of them all, bitcoin, went from approaching $60,000 per bitcoin at the end of 2021 to just over $30,000 on Friday, May 13th. The same goes for all these dematerialized currencies, whose total capitalization has halved over the same period.

Blame it on the Fed

“For those who are panicking, here is a list of moral support phone numbers,” says one of the many cryptocurrency sub-forums on the popular Reddit community site.

“There is clearly a fiasco going on in this sector right now,” admits Natalie Janson, an economist and crypto specialist at Neoma Business School. But this isn’t the first time prices have plummeted before rising to seventh heaven in the stock market at all. So, just a year ago, “in the same period, bitcoin lost 50% of its value after China’s decision to restrict the use of this currency,” recalls this expert.

She notes that each of these brutal price corrections had a “logical reason,” whether it was a political decision by Beijing or a backlash from investors overexcited, as during the first “crypto winter” in 2017.

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Descent into Hell 2022 is no exception to this rule. This time, the US Federal Reserve is to blame. Cryptocurrencies are reacting in much the same way as the rest of the tech stocks, which had a disastrous start to the year due to the US Fed’s decision to raise interest rates.

“When interest rates rise, less risky investments that depend on these rates, such as bonds, generate more returns, which can lead investors to turn away from riskier investments, such as cryptocurrencies,” summarizes Natalie Janson.

But in many ways, Bitcoin’s big drop is also unusual for traditional currency yo-yo effects. First, because the Fed hasn’t finished raising rates. It will continue to do so as long as it considers it necessary to fight inflation. Unlike previous crises, this is not a one-time event that investors simply need to adjust to and then allow the price of bitcoin to recover to new highs. The downtrend this time may last longer and be deeper.

Terra, the stablecoin that destabilizes everything

Moreover, a crisis within a crisis. An important part of the entire ecosystem began to falter. “Failures in the operation of the Terra cryptocurrency accelerated the fall in prices,” says Natalie Janson.

What is it about ? Terra is what is called a stablecoin, that is, a cryptocurrency whose price, unlike the vast majority of its sisters, (almost) does not change. It is even one of the largest after Tether, which is worth $80 billion. These stablecoins achieve this by typically being pegged to a “real” currency such as the dollar.

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For Terra, it is a little different: it is not tied to another currency, but is a complex algorithm that ensures that its rate does not deviate from 1 terra = 1 dollar…. in theory.

Except that in practice, the price of this stablecoin dropped to almost 20 cents at the beginning of the week. Unprecedented Mystery Event: “Terra’s reserves went from $14 billion to $9 billion on Friday, May 6th, and no one knows who pulled all that money,” notes Natalie Janson.

But whoever the culprit was: Investors saw it as a signal that something was wrong in the realm of this stablecoin. Then they began to get rid of their Terra, accelerating the fall of this cryptocurrency.

We then started talking about the Lehman Brother stablecoin moment with the collapse of Lehman Brother Bank in 2008, which led to cascading bankruptcies of other institutions. The contagion phenomenon seems to have taken hold in the cryptocurrency world as well, as even Tether briefly lost parity with the dollar on Thursday, May 12.

The first crisis of the era of democratization of cryptocurrencies

For the ecosystem as a whole, failures in the operation of these stablecoins can be fatal. Indeed, exchanging a cryptocurrency for a currency such as the dollar or the euro always goes through a stablecoin first. This is a kind of mediator that calms everyone, providing stability.

If no one trusts Terra, Tether, and the rest, there will simply be no more deals in a cryptocurrency market that is worth $1,300 billion anyway and invested in by pension funds, major banks, and idealistic geeks. Ironically, this is one of the systemic risks for the sector highlighted by the Global Financial Stability Board in a report published in February 2022.

Finally, this crisis is unprecedented in terms of the scale of losses inflicted on mere mortals. This is the first price drop in the era of “democratization of cryptocurrencies,” emphasizes Natalie Janson. Two or three years ago, only insiders invested in this type of asset. Today, the Reddit forums and most of the articles discussing this deadly bitcoin spring are filled with testimonials from people who “lost all their savings.”

A sad reality that can be explained by the rush to the stock exchange by small investors on Sundays during the pandemic. Often young and very connected, they often turned to cryptocurrencies that seemed to carry ambitious projects while offering very attractive interest rates.

“Today, many students have invested in these assets to pay for part of their studies,” says Natalie Janson. For them, this is the whole world, which is threatened with collapse with this crisis.