Cryptocurrencies: Anatomy of Carnage

The value of all cryptocurrencies has fallen in recent days. A movement which, by its magnitude, recalls the darkest hours in the history of bitcoin, but whose singularities can make it a particularly painful episode for the economy.

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

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

Blame it on the Fed

“For anyone panicking, here is a list of phone numbers for moral support services,” reads one of the many cryptocurrency subforums on the popular community site Reddit.

“There is clearly a debacle currently in this sector”, recognizes Nathalie Janson, economist and specialist in cryptocurrencies at Neoma Business School. But this is not the first time that prices have fallen sharply before, generally, rising to seventh stock market heaven. Thus, barely a year ago, “during the same period, bitcoin had lost 50% of its value after China’s decision to limit the use of this currency”, recalls this expert.

She points out that each of these brutal price corrections had a “logical reason to occur”, whether it was a political decision by Beijing or the backlash of too much investor excitement as during the first “crypto winter”, in 2017.

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The descent into hell of 2022 is no exception to this rule. This time, the US Federal Reserve would be to blame. Cryptocurrencies are reacting, in fact, like the rest of tech stocks which had a disastrous start to the year due to the decision of the American Fed to raise interest rates.

“When interest rates rise, less risky investments that depend on these rates – such as bonds – yield more, which can lead investors to abandon riskier investments such as cryptocurrencies”, summarizes Nathalie Janson.

But in many ways, bitcoin’s big plunge is also out of the ordinary for the currency’s traditional yo-yo 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 adapt to and then let bitcoin’s price rebound to new highs. The downtrend this time may last longer and turn out to be deeper.

Terra, the stablecoin that destabilizes everything

Furthermore, there is a crisis within the crisis. An important part of the whole ecosystem has begun to malfunction. “The disruptions of the Terra cryptocurrency accelerated the fall in prices,” says Nathalie Janson.

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

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

Except that in practice, the price of this stablecoin fell to nearly 20 cents at the start of the week. An unprecedented event linked to a mystery: “Terra’s reserves rose on Friday, May 6, from 14 billion dollars to 9 billion dollars, without anyone really knowing who withdrew all this money”, notes Nathalie Janson.

But whoever the culprit: investors saw it as a signal that something was wrong in the kingdom of this stablecoin. They then began to get rid of their Terra as well, accelerating the fall of this cryptocurrency.

We then began to talk about the “Lehman Brother” moment of stablecoins, in reference to the collapse of the Lehman Brother bank in 2008 which led to cascading bankruptcies of other institutions. A contagion phenomenon also seems to have started to operate in the world of cryptocurrencies, since even Tether briefly lost its parity with the dollar on Thursday, May 12.

The first crisis of the era of the democratization of cryptocurrencies

For the ecosystem as a whole, malfunctions of these stablecoins could be fatal. Indeed, exchanges from a cryptocurrency to a currency like the dollar or the euro always go through a stablecoin first. It’s a bit of an intermediary that reassures everyone by providing stability.

If no one trusts Terra, Tether and others, there will simply be no more transactions in the cryptocurrency market, which is worth, all the same, 1,300 billion dollars and in which pension funds, biggest banks as well as idealistic geeks have invested. Ironically, this is one of the systemic risks to the sector singled out by the Global Financial Stability Board in a report published in February 2022.

Finally, this crisis is unprecedented in terms of the scale of the losses caused to ordinary mortals. This is the first drop in prices in the era of “democratization of cryptocurrencies”, underlines Nathalie Janson. Two or three years ago, only insiders invested in this type of asset. Today, the Reddit forums and the majority of articles discussing this deadly spring for bitcoin are full of testimonials from individuals who “lost all their life savings”.

A sad reality which is explained by the rush to the Stock Exchange of small investors on Sunday during the pandemic. Often young and very connected, they often turned to cryptocurrencies which seemed to carry ambitious projects while offering very attractive interest rates.

“There are a good number of students today who, to pay for part of their studies, have invested in these assets”, says Nathalie Janson. For them, it’s a whole world that threatens to collapse with this crisis.

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