Crypto

Analysis | How a series of crypto meltdowns are reshaping the industry

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The history of cryptocurrencies has rarely been boring, but the latest crisis brought a series of shocks that shook the foundations of digital assets. A cascade of explosions, including the collapse of a so-called stablecoin in May and the epic unraveling of crypto exchange FTX in November, left a wave of bankruptcies. The events eroded the confidence of more traditional investors who were keen to capitalize on the growing interest in Bitcoin and the vision of decentralized finance. The turmoil has prompted regulators to act more urgently to protect consumers.

1. What happened to crypto prices?

After peaking in November 2021, crypto assets suffered a $2.2 trillion wipeout over the following 12 months, with their combined market value dropping 73%, according to data from tracker CoinGecko. In the past, such meltdowns — also known as “crypto winters” — were triggered by events within the industry itself, such as an exchange failure or a regulatory crackdown. This one started with something external: central banks raised interest rates to combat a post-pandemic inflation spike, which reduced investors’ appetite for riskier assets, including crypto.

2. What is the meaning of this?

The crash exploded the idea that crypto enjoys a similar status to gold as a safe haven in times of economic uncertainty by being decoupled from the fortunes of traditional financial assets. It came as a shock to pension fund and sovereign wealth fund managers – and millions of retail investors – who have embraced crypto in recent years in the belief that it was becoming a mainstream asset class. It turned out that the 2021 crypto rally was on shaky ground, as many investors borrowed heavily to bet on coins and digital projects, often using other cryptos as collateral. This interconnection extended the impact of high-profile failures.

The biggest explosion involved a so-called algorithmic stablecoin called TerraUSD – a digital token whose value was supposed to be pegged to the US dollar through the use of a parallel currency, Luna. It became popular when users of a decentralized finance (DeFi) platform called Anchor were offered interest rates of up to 20% for TerraUSD deposits. Sudden withdrawals from Anchor caused the value of TerraUSD to plummet, and within days he and Luna had entered a death spiral that wiped around $60 billion from their value. Companies that had invested in tokens and related derivatives, such as Three Arrows Capital, eventually failed, leading to the bankruptcy of other companies, such as Voyager Digital, which had provided a massive loan to Three Arrows. In November, there was another shock: the implosion of star entrepreneur Sam Bankman-Fried’s crypto empire, including one of the largest digital asset exchanges, FTX. The platform, which had played a significant role in making crypto attractive to more traditional investors, had a tangled web of related entities with lax record keeping and poor centralized controls. FTX’s collapse was still causing aftershocks in January when Genesis Global Holdco LLC, which had funds tied up in FTX, filed for bankruptcy owing at least $3.4 billion in unsecured debt. The crypto lender had suspended withdrawals shortly after FTX was declared insolvent.

4. What were the consequences?

Critics have said that many crypto projects are doomed because they rely in part on offering unsustainable returns. They likened some high-yield companies to new forms of Ponzi schemes, funding payouts to existing investors using deposits from newbies. The implosion of FTX and the subsequent failure of Genesis underscored the dangers of contagion, in which problems in one corner of the industry spread quickly and unexpectedly, triggering huge losses elsewhere. All of this could freeze crypto investments for some time.

5. Where does this leave the industry?

Crypto was invented following the global financial crisis of 2008, which eroded trust in traditional institutions. But the spate of scandals in 2022 raises what amounts to an existential question of whether crypto can be trusted either. For many, the hope was that stricter regulation could restore confidence. But the bankruptcy of FTX apparently derailed legislation that had been strongly urged by Bankman-Fried. It had been opposed by some DeFi platform operators, who saw it as biased in favor of large centralized exchanges like FTX. Tighter regulation could eventually make crypto a more stable and respectable investment. What is unclear is how well the industry can withstand the kind of scrutiny this would entail.

More stories like this are available at bloomberg.com

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