Why this cryptocurrency is different
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The bubble of decentralized finance (DeFi) / centralized finance (CeFi) is bursting, mania with non-fungible tokens (NFT) is burning by itself, algorithmically stable coins are collapsing and crypto lenders are breaking down. Crypto is in a bear market.
Cryptosceptics inevitably call “the end of crypto.” But we have seen this type of correction before. Several times, in fact. In 2014, the price of bitcoin crashed when Mt. The Gox stock market collapsed. And in 2018, the price of bitcoin fell by 80% when hundreds of “initial coin offerings” (ICOs) crashed and burned. In both cases, the market eventually recovered, and cryptocurrencies rose higher than before. Although bitcoin has lost 70% of its dollar value since November last year, it is still worth more than the peak in December 2017. So why not HODL and wait for the market to recover?
Frances Coppola, a CoinDesk columnist, is a freelance writer and lecturer on banking, finance and economics. Her book “The case for people’s quantitative easing“explains how modern money creation and quantitative easing work, and advocates” helicopter money “to help economies out of recession.
But this time is really different. Driven by war and pandemic, a new macroeconomic paradigm is formed. High inflation is back after 30 years of absence, and with it much tighter monetary policy. Interest rates are rising, and central banks around the world are burning money. The time of plenty of dollars is coming to an end. And that will mean persistently lower prices for cryptocurrencies.
Crypto markets have never known anything but simple money. Bitcoin was born in the wake of the financial crisis in 2008, when many feared that the central banks’ experiment with ultra-low interest rates and quantitative easing (QE) would lead to current inflation. Ten years later, interest rates were still well below pre-financial crisis levels, and central bank balances were still massively inflated. And the current inflation forecast by bitcoiners had not emerged. Instead, asset prices had risen massively – including cryptocurrency prices, as investors desperately after returns piled up in bitcoin and other cryptocurrencies.
There was a short period of relative dollar scarcity from 2016 to 2018, when the Fed raised interest rates and burned money (“quantitative easing”) and the US Treasury Department issued bonds (which also burn fiat money). But as the Fed tightened, other central banks loosened. QE never really ended; it has just moved around the world. And in 2019, when the dollar shortage caused disturbances in the repo markets, the Fed began injecting money again.
Then came the pandemic. When governments shut down businesses and distributed money to people who were unable to work, central banks embarked on the most exorbitant money-creation programs in history. Much of this money found its way into crypto markets, raising prices to unprecedented levels and promoting the rapid growth of high-yield lending, complex synthetic assets and toxic derivatives of a type last seen before the 2008 financial crisis. it a cryptocurrency that fed insanity. Pension funds, hedge funds, software companies, football clubs and celebrities all came on the scene, and many ordinary people earned life-changing amounts.
The lush growth of the crypto industry since Bitcoin emerged from the ashes after the financial crisis – and especially since March 2020 – can be directly attributed to the abundant fertilizer central banks have poured into the financial markets.
But now we have inflation. Economists are debating whether this inflation is mainly caused by supply disruptions or excessive demand, and whether it will be temporary or long-lasting. Does not matter. Central banks, under pressure to control inflation, quickly remove the monetary fertilizer and get out the pruning shears. The markets with the most prosperous growth will have the strongest cuts.
It may be easy to see why the end of simple money can mean disaster for those who are invested in a cryptocurrency with a high loan, but it is less obvious why it makes bitcoin sell out. You would think it would encourage people to jump into deflationary cryptocurrencies like bitcoin. After all, bitcoin was originally meant to replace the dollar, and some still believe it will eventually. What better time to buy and HODL the world’s future currency than the start of the inflationary Armageddon that will cause the dollar to fall away as the world’s most important reserve currency?
But most people who have invested in cryptocurrency now do not want to replace the dollar. In fact, they fear it will be replaced. What they want is to get rich in dollars. So cryptocurrency rates are usually quoted in dollars, most cryptocurrencies involve stable dollar-denominated coins, and dollar-denominated stable coins are widely used as collateral for cryptocurrencies.
The crypto ecosystem is firmly rooted in the traditional financial system, and the dollar dominates the crypto markets just as it does traditional financial markets. And as the crypto markets have grown, so has the dollar value of the cryptocurrency industry.
But these dollars are not real. They exist only in the virtual space. They are not, and never were, guaranteed by the only real world institution that can create real dollars, the Fed. The Fed has no obligation whatsoever to ensure that those who have earned life-changing amounts of these “virtual dollars” can actually exchange them for real dollars. So when the crypto bubble bursts, the “virtual dollars” simply disappear. If you can not exchange your virtual dollars for real dollars, your fortune is an illusion.
David Z. Morris – How I did it: From Pro Balls to Master of DAOs
The only real dollars in the cryptocurrency industry are those paid by new entrants when they make their first cryptocurrency purchases. The rest of the dollar liquidity in crypto markets is provided by dollar-denominated stack coins. These fall into two groups: those who have actual dollars and / or dollar-denominated safe liquid assets that support them, and those who do not. There are not enough of the former to make it possible for everyone to pay out for real dollars, and there is no guarantee that the latter can be paid out for real dollars at all. So in reality, the entire crypto industry is partially reserved.
There is now a race to swap cryptocurrencies for the few real dollars that are still available. As always in unregulated markets, the law of the jungle applies. Those with the biggest teeth get the dollar. Maybe “whales” is the wrong name for them. Crocodiles are perhaps more like that.
When everyone tries to pay out cryptocurrencies at increasingly scarce dollars, cryptocurrency prices quickly fall to the level where there are enough dollars in the system for everyone to withdraw money. For derivatives and synthetics it probably means zero. After all, if the underlying assets fall rapidly in price, then who wants the derivatives? And synthetic drugs are, as the name suggests, not real. When it’s a flight to reality, unreal things are worthless.
If tighter money has come to stay, as many expect, continued scarcity of dollars will make it impossible for crypto to rise again as it has done before. Rather, it will have to adapt to the new paradigm. It can return to its roots, avoid the dollar and value crypto only in relation to itself: “1 BTC = 1 BTC”, as bitcoin maximalists like to remind us. Alternatively, it can attract more real dollars by developing real-world use cases, instead of relying on network effects to pump up dollar values that are unrealistic in practice. But this is unlikely to generate the high dollar values of the past.
While the Fed does money tightening, and there is no Fed guarantee or Federal Deposit Insurance Corp. (FDIC) insurance for cryptocurrency deposits, there can be no return to the highly leveraged, fractions reserved cryptocurrency system whose illusory wealth now gives way to real losses.
