The collapse of a multimillion-dollar cryptocurrency called land has sparked a wave of “fear, uncertainty and doubt” across the industry, leading some, such as Coinbase CEO Brian Armstrong, to suggest that the industry is moving towards another. ” cryptographic winter “. But how did the stumble of a coin cause such panic? And could a recession spill over into the wider economy?
How does cryptography work?
The term cryptocurrency covers a wide range of digital assets based on the same fundamental structure as bitcoin: a publicly available “blockchain” that registers ownership without having any central authority in control. Proponents of her case have been working to make the actual transcript of this statement available online.
Critics say that more than a decade after the creation of bitcoin, the industry has not yet generated a really useful product, but simply allowed the creation of a wave of speculative bubbles and zero-sum games of chance that have lost some retail investors so much money. as he did for others.
Both sides agree that the recent collapse of the cryptocurrency market is evidence of declining interest, but the real question is whether it is simply temporary or a more permanent crisis that will expose the large number of scams and frauds that pervade the sector.
What is the status of the cryptography?
Nearly half of the total value of the sector, $ 582 billion (£ 475 billion), is still tied to the original cryptocurrency, bitcoin. Half of the new $ 250 million is in ethereum, a more programmable successor to bitcoin, which provides the infrastructure that underpins many other projects.
Then there are the stable currencies, whose most important examples, such as Tether ($ 80 million) and USD Coin ($ 50 million), are effectively the banks in the sector, which take customer deposits, hold them as reserves and issue tokens that supposedly are guaranteed. a fixed value relative to conventional currencies.
The projects that are located on top of that layer of infrastructure are comparatively small. This includes non-fungible tokens or NFTs, unique assets that are used to indicate ownership of assets such as digital art. According to analytics firm CoinMarketCap, the entire NFT sector is worth $ 10 billion. Meanwhile, the “decentralized finance” (DeFi) sector, which seeks to mimic traditional banking services such as foreign exchange, current accounts and loans, is worth less than $ 70 billion.
What caused the accident?
Despite hopes among fans that cryptocurrencies, particularly bitcoin, would act as a countercyclical investment and as a hedge against inflation, the sector began to contract at the same time as the wider sale of technology, with bitcoin falling from $ 48,000 in March to less than $ 38,000. in early May.
However, last week the collapse of the stablecoin land precipitated a much sharper fall. Unlike its larger rivals, Terra had no customer deposits to support it; instead, its stable value of $ 1 was based on faith in its underlying algorithm, which maintained its value by printing a sister, moon cryptocurrency. But over the course of Monday and Tuesday that faith was shattered when the earth “deviated” from the dollar and fell into a “spiral of death,” automatically printing an increasingly worthless moon, which further lowered the price.
By the end of Thursday, the market capitalization of the project had dropped from $ 41 billion to $ 6.6 million, “the biggest destruction of wealth … in a single project in the history of cryptocurrency,” according to Charles Hayter of the analysis firm CryptoCompare. Until Monday, land was trading at just $ 0.11.
How did it spread?
The initial collapse of Earth caused a new wave of sales, reducing the value of most major cryptocurrencies by 15-25%. The rush to get out of the market hit the stable currencies especially hard, causing the tether to fall apart for most of Wednesday, Thursday and Friday. Since then, the company has approved $ 7.6 billion withdrawals that have returned the token to 0.1% of parity with the U.S. dollar.
Other projects are most directly affected by the landslide. Hayter warns that there is “significant exposure” in much of the DeFi industry, as well as traditional land-dependent financial products to deliver high returns to depositors. Celsius Network, for example, offered an annual interest rate of 18% on stablecoin deposits, while Avalanche, a blockchain project, invested $ 100 million in it.
On Friday morning, the DeFi Venus protocol announced that it had lost $ 13.5 million from its treasury after it accidentally accepted land using an outdated valuation, while Blizz Finance lost all of its holdings due to the same defect.
“We believe that the volatility of the market in the ecosystem will take time to decrease; in the coming weeks we will find out the true cost of this accident,” says Hayter.
The contagion will spread beyond cryptography?
Nikolaos Panigirtzoglou, a global market strategist at US investment bank JP Morgan, says tether bailouts could cause problems in credit markets because Tether’s collateral includes commercial paper, a form of short-term corporate debt used by companies to cover monthly expenses. payroll. “It will be a problem for credit markets if you want to sell a lot of commercial paper in a short amount of time,” he says. Tether’s commercial paper reserves total just under $ 30 billion.
Panigirtzoglou also warns of the risk of a wider sale of assets by retail investors attending to losses. “Investors in cryptocurrencies who have lost a lot of money and who have also invested in stock markets could decide to eliminate the risk by removing their money from the stocks.” However, he says the prospect of a stock sale was less likely because stock prices have fallen in recent months and retail investors may not want to aggravate their cryptocurrency losses.
I could does contagion cause a credit collapse in style?
Not how the market is today, according to James Knightley, ING’s chief international economist in New York. Cryptography is not as systemically important as housing, the trigger for the 2008 financial crisis. “It may not be particularly important now from a systemic point of view, but if the crypto markets were to recover and grow strongly in the coming years and then have a second fall when it is systemically important, regulators could not be forgiven.”
Teunis Brosens, ING’s chief economist in digital finance and regulation, said there would be a systemic risk if insurers and banks became more involved in cryptocurrency assets, although this is less likely to happen when regulators circulate. “Increased participation and exposure of traditional financial institutions [to cryptocurrencies] it is primarily limited to asset managers, who pass on losses to their customers. “