Cryptocurrencies: the anatomy of cutting

In recent days, the value of all cryptocurrencies has fallen. A movement that is reminiscent of the darkest times in the history of bitcoin, but its features can make it a particularly painful episode for the economy.

Two hundred billion dollars went up in smoke in 24 hours, the CoinMarketCap website, which monitors the evolution of cryptocurrencies, estimated on Thursday, May 12. The latter are currently crossing a zone of very strong turbulence, recording repeated losses and which seem endless.

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

Blame the Fed for this

“For those who are scared, here is a list of phone numbers of moral support services,” said one of the many cryptocurrency subforums on the popular Reddit community site.

“Obviously, there is a catastrophe in this sector right now,” said Natalie Janson, an economist and cryptocurrency specialist at Neoma Business School. But this is not the first time that prices have fallen sharply before generally rising to the seventh stock market sky. So, only a year ago, “during the same period, bitcoin lost 50% of its value after China’s decision to limit the use of this currency,” – said the expert.

She notes that each of these brutal price adjustments had a “logical reason”, whether it was Beijing’s political decision or the negative reaction of too much investor excitement, as during the first “cryptocurrency” in 2017.

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Rise to hell in 2022 is no exception to this rule. This time the US Federal Reserve will be to blame. Cryptocurrencies react, in fact, like other technology stocks, which had a disastrous start to the year due to the decision of the US Federal Reserve to raise interest rates.

“As interest rates rise, less risky investments that depend on those rates, such as bonds, yield more, which may force investors to abandon riskier investments such as cryptocurrencies,” said Natalie Janson.

But in many ways the big drop in bitcoin is also unusual for traditional yo-yo currency effects. First, because the Fed has not finished raising its rates. It will continue to do so as long as it deems 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 bitcoin prices to jump to new highs. The downward trend of this time may last longer and be deeper.

Terra, a stablecoin that destabilizes everything

In addition, there is a crisis inside the crisis. An important part of the whole ecosystem began to fail. “Violations in the cryptocurrency Terra have accelerated the fall in prices,” – says Natalie Janson.

What is it about? Terra is what is called stablecoin, a cryptocurrency whose price, unlike the vast majority of its sisters, is (almost) unchanged. It is even one of the largest, after Tether, which is worth $ 80 billion. These stablecoins achieve this, usually tied to the “real” currency, such as the dollar.

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

Except that in practice the price of this stablecoin fell to almost 20 cents at the beginning of the week. An unprecedented mystery event: “Terra’s reserves rose from $ 14 billion to $ 9 billion on Friday, May 6, and no one really knows who withdrew all that money,” said Natalie Janson.

But whoever was to blame: investors took it as a signal that something was wrong in the kingdom of this stablecoin. Then they began to get rid of their Terra, accelerating the fall of this cryptocurrency.

Then we started talking about the Lehman Brother moment with stablecoins, referring to the collapse of Lehman Brother in 2008, which led to the cascading bankruptcies of other institutions. The phenomenon of infection also seems to have taken effect in the cryptocurrency world, 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 of these stablecoins can be fatal. Indeed, the exchange from a cryptocurrency to a currency like the dollar or the euro always comes first through a stablecoin. It’s a bit of a mediator that reassures everyone while providing stability.

If no one trusts Terra, Tether and others, the cryptocurrency market, which is still worth $ 1,300 billion and in which pension funds, the biggest banks, and idealistic geeks have invested, will simply no longer have transactions in the cryptocurrency market. Ironically, this is one of the systemic risks to the sector identified by the Global Financial Stability Board in its February 2022 report.

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

The sad reality is due to the rush to the stock market of small investors on Sunday during the pandemic. Often young and very connected, they often turned to cryptocurrencies, which seemed to be implementing ambitious projects, while offering very attractive interest rates.

“Today, there are a large number of students who have invested in these assets to pay for part of their tuition,” says Natalie Janson. For them, this is a world that is in danger of collapsing with this crisis.