How The Crypto Crash Affects You

Cryptocurrency has incinerated over $1 trillion and the result will be very bad for the economy.

For a moment, forget all about the toll that cryptocurrencies such as Bitcoin and Tether take on the power grid, because that's almost nominal in comparison to the damage they just did to money supply. In case you missed it, crypto markets are in the toilet. For those who had hoped that decentralized currency would replace fiat money and usher in a new world era of peace and prosperity, the crypto market crash has been undeniably brutal. With cryptocurrency markets losing almost $1.7 trillion in value over the past five months, the well overdue death of the crypto farce finally seems to have arrived.

But what will the cost of this long-overdue crash be?

To give some background, the market value of cryptocurrencies was nearly $3 trillion on Thanksgiving in 2021, but by the time the IRS (USA) tax filing deadline of April 18 came around, crypto markets had fallen to $2 trillion.

As of the writing of this article, crypto markets have plunged further by 35%, to about $1.3 trillion.

Many critics of cryptocurrencies have long argued that crypto will disappear because it is based on nonsense, and it further helps criminals move contraband and launder money. This recent major crash with crypto will only solidify the position of those detractors and convince many others that critics were right all along.

Regardless, this is unlikely to lead to the ultimate downfall of cryptocurrency. Rather, this latest crash is probably the casus belli that governments have been waiting for to take full control of crypto markets. In this way, a type of sorting process is now happening where the most dubious and criminal aspects of the crypto world are being exposed, while those with at least a shred of legitimacy are being recognized.

The result will be that regulators finally will have to do something about cryptocurrency, and pass legislation for solid regulation.

The tide went?out

In the finance world, popular financial axioms are often tossed about by investors, such as “buy the rumour, sell the fact”, and “markets can stay irrational longer than you can stay solvent.” These sayings are old, and they oftentimes prove to have truth behind them. As cryptocurrencies have plummeted in value and crypto markets are collapsing, one saying appropriate for the moment might be:

“When the tide goes out, you find out who is swimming?naked”.

Prior to the crash, the crypto market was like a bunch of people who were swimming in the ocean and telling people on the beach to get into the water, however, first, one needed a bathing suit. Naturally, the people who were claiming that the water was great were also selling their bathing suits to buyers on the land.

Unfortunately, once the tide went out, many of those buyers found themselves beached because a lot of those salesmen had been swimming naked all along.

Today, investors are already beginning to discriminate between those who have been exposed as nothing more than nude charlatans, and the vendors who actually had swimsuits on.

The technicals spell further?doom

The crypto collapse is part of that broader slump triggered by scolding hot inflation that is forcing central banks to tighten monetary policy, which had triggered a sell-off in riskier or long-dated assets. It’s no different than what happened with Netflix when the bond market interest rates went up.

Since investors had a better option for guaranteed growth, many bailed on tech stocks. This is why after a heavy sell-off on May 18th, the tech-heavy NASDAQ index is down by 29% from its high, while other indices were less punishing.

Crypto itself, a darling of many tech and retail investors, is now in a technically precarious situation that promises more pain for investors of digital currency.

This is since crypto typically isn’t backed by anything other than sheer libertarian-like confidence of investors that their digital coins ought to be worth something. As a result, many investors turn to what is known as Technical Analysis (TA) to try and predict the future of their currencies.

Simply put, TA is a method for examining charts and finding patterns that tell investors when they should buy and sell. It’s a dubious practice, to say the least, that depends upon everyone looking for the same patterns and reacting the same way.

For example:

In this chart, we see a clear reversal pattern known as a head and shoulders, which is one of the most well-known signals amongst TA enthusiasts, who are of course a majority of the crypto investors.

So what does that mean? Because the TA signal says that the markets are reversing, all the investors who believe in the chart signal nonsense will follow suit and sell their crypto, which will, in fact, create an actual reversal.

In other words, when it comes to crypto, TA is a self-fulfilling prophecy because everyone will believe and do the exact same things depending upon the charts, and so the signals themselves become the reality.

Right now, the signals show more selling, and so people will sell, and thus the markets fall further.

Diapers are more dependable

Crypto is at the top of the list of speculative assets that are being crushed, and this is because of the exposed glaring weaknesses being discovered in the wake of the market crash. A great example of these weaknesses can be seen in the so-called “algorithmic” stablecoin known as Terra.

Many crypto enthusiasts celebrated Terra as a benchmark for the future of digital currencies since the coin was claimed to be backed by other assets, which supposedly made it more dependable.

The way Terra works is as follows:

Users of Terra could easily redeem $1 worth of Terra for $1 worth of another cryptocurrency, Luna, which itself was offered based upon demand. If someone used Terra, and they wanted to exchange it for Luna, then the crypto gods would just breathe into existence as many Luna coins as needed to make the exchange possible.

The idea was that by having this alternative coin supporting Terra, both coins would be far less volatile. Unfortunately, the brainchild who masterminded this concept failed to properly anticipate just how destructive a good financial panic can be.

Luna’s price began to slide in early May, which put pressure on the peg to Terra, since investors of Terra started to freak out. After all, if they depended upon Luna to provide value to their precious Terra coins, and Luna was sliding, they might be left holding worthless digital coins on their hard drives.

Naturally, there was a rush to redeem Terra which caused Luna’s supply to balloon, and thus its price utterly collapsed.

The resulting self-fulfilling prophecy saw just 350 million Luna tokens in the world on May 10th, but as of the writing of this article, there are 6.5 trillion.

At its peak, Luna was worth a whopping $40 billion, and it supported $18 billion worth of Terra. Today, Luna is worth less than a used diaper, because even a used diaper can be washed and reused.

Meanwhile, Terra is trading at just 10 cents (USD).

So much for “stablecoins.”

The regulators will save the?USD

It’s not all doom and gloom for crypto. For example, the USDC, a stablecoin backed by cash and short-dated T-bills and which publishes audited financial statements each month, is doing just fine. The same holds for several other stablecoins that are backed by a variety of tangible assets and run by algorithms.

DAI, a stablecoin that has a decent degree of transparency and holds at least 1.5 times as much asset backing as it needs to stay stable, has so far managed to use the principles of diversification to maintain value and stability. Furthermore, the supply of the backing cryptocurrencies that DAI relies upon are independently controlled and are themselves pegged to fiat currency.

These types of digital currencies seem like no brainers for regulators to legitimize since they depend upon government-backed currency and can be used to set the standard for how all cryptocurrencies should operate, and are likely the currencies that might survive the crypto bloodbath largely unscathed.

On the other hand, the currencies that will likely face heavy scrutiny from regulators are probably the big stablecoins such as Tether, which claims to be backed by assets like cash, bonds, and corporate debt — however, the disclosures of Tether are absolutely hideous.

Tether refuses to reveal the precise asset mix that it is backed by because it claims it to be the “secret sauce.”

That’s not a joke, they actually said that.

Imagine if Wells Fargo tried to tell the SEC that they can’t disclose their assets because it’s a hidden recipe to success.

Not surprisingly, Tether has previously been fined by New York’s attorney-general for misleading investors, with more fines likely on the way.

While this type of open-faced defiance has worked for Tether for a while, the broader market sell-off in the past weeks has holders of Tether very nervous, particularly since it slipped from its peg, meaning that it can no longer be easily exchanged for 1-to-1 for the USD.

After the dip below the peg, Tether holders have redeemed about $9 billion worth of tokens, which is approximately 10% of the total in the market.

This never would have happened if Tether had proper disclosures proving that they had enough assets to support the 1-to-1 exchange with the dollar, and that is precisely what legislators and regulators will be saying when they make the argument for new policies for policing crypto.

Putting it all?together

While many investors are naturally punishing crypto organizations via free-market instruments, the crypto crash has sparked an outcry for governments to start regulating digital currency in a major way. While wealthier more savvy traders will survive this downturn, the damage done to the middle of the road consumers cannot be understated and will likely be irreversible.

Worse perhaps is that the result of this crash will be less money supply in a market that is already strapped for cash.

Most worrisome, however, is that the volatility of crypto markets could easily spill over into the conventional financial system, primarily because so many stablecoins are tied to actual tangible assets. Therefore, the price of the assets that were backing crypto could fall suddenly, which could cause a panic and result in a broader sell-off across all financial markets.

Many people would like the cryptosystem banned altogether since they view it as a giant global scam that helps criminals do terrible things, while others would like to see crypto heavily regulated similar to banks.

Perhaps most interesting are the people who say that full regulation is needed, however, their fear is that this might legitimize something that should not have an official endorsement by governments.

Their fear is reasonable.

It is true that if managed properly, crypto could potentially provide new and innovative financial products and property rights, as well as the possibility of a less centralised financial system. For this reason, draconian measures and a proverbial crackdown on crypto are probably a bad idea.

On the other hand, failures in the crypto market have proven to be terribly destructive to the global economy, and could potentially bring the traditional financial markets to their knees.

So what are governments to do?

Perhaps the best way forward is to accelerate the process of sorting the good from the bad. How do we do this?

First, more reliable information must be provided by organizations who manage crypto, particularly pertaining to the assets that back the digital coins themselves. Second, advanced high finance nations such as America, Britain, and much of Europe, must all get on the same page and require that crypto be traded on actual exchanges, thus making it far easier to regulate.

All of this wouldn’t necessarily stop clandestine crypto from existing, but it would make it clear to investors which ones were wearing proper attire.