The history of cryptocurrencies has rarely been dull, but the latest meltdown delivered a series of shocks that shook the foundations of digital assets. A cascade of explosions, including the collapse of a so-called stablecoin in May and the epic dissolution of the FTX crypto exchange in November, left a wave of bankruptcies. The events eroded the confidence of more mainstream investors eager to capitalize on growing interest in Bitcoin and the vision of decentralized finance. The turmoil has led to calls for regulators to act more urgently to protect consumers.
How a series of crypto meltdowns is reshaping the industry
1. What happened to crypto prices?
After peaking in November 2021, crypto assets were wiped out in the following 12 months, with a combined market capitalization of 73%, according to data from tracker CoinGecko. In the past, such collapses – also known as “crypto winters” – were triggered by events in the industry itself, such as the failure of an exchange or a regulatory breach. This one started with something external: central banks raised interest rates to combat a post-pandemic spike in inflation, reducing investors’ appetite for riskier assets, including crypto.
2. What is the meaning of it?
The crash exploded the idea that crypto enjoys a similar status to gold as a safe haven in times of economic uncertainty by being decoupled from the fortunes of traditional financial assets. It came as a shock to pension and sovereign wealth fund managers – and millions of small investors – who embraced crypto in recent years in the belief that it was becoming a mainstream asset class. It turned out that the 2021 crypto rally was built on shaky foundations because many investors borrowed heavily to bet on digital coins and projects, often using other crypto as collateral. This relationship diffused the impact of high-profile failures.
The biggest explosion involved a so-called algorithmic stablecoin called TerraUSD – a digital token whose value was meant to be tied to the US dollar through the use of a parallel currency, Luna. It became popular when users of a decentralized finance (DeFi) platform called Anchor were offered interest rates as high as 20% for TerraUSD deposits. Sudden withdrawals from Anchor drove TerraUSD’s value down, and within days both it and Luna had entered a death spiral that wiped about $60 billion off their value. Companies that had invested in related tokens and derivatives, such as Three Arrows Capital, ended up going bankrupt, leading to the failure of other companies, such as Voyager Digital, which had given Three Arrows a massive loan. In November, there was another shock: the implosion of star founder Sam Bankman-Fried’s crypto empire, including one of the largest exchanges for digital assets, FTX. The platform, which had played an important role in making crypto appealing to more mainstream investors, had a tangled web of related entities with lax record-keeping and poor centralized control. The FTX collapse caused further aftershocks in January when Genesis Global Holdco LLC, which had funds tied up in FTX, filed for bankruptcy owing at least $3.4 billion in unsecured debt. The crypto lender had suspended withdrawals soon after FTX was declared insolvent.
4. What were the consequences?
Critics said many crypto projects were doomed to failure as they relied in part on offering unsustainable returns. They compared some high-yield ventures to new forms of Ponzi schemes, which fund payouts to existing investors using deposits from new ones. The implosion of FTX and subsequent failure of Genesis underscored the dangers of contagion, where problems in one corner of the industry spread quickly and in unexpected ways, triggering heavy losses elsewhere. All this can freeze investments in crypto for some time.
5. Where does this leave the industry?
Crypto was invented in the wake of the 2008 global financial crisis, which eroded trust in traditional institutions. But the string of scandals in 2022 raises what amounts to an existential question of whether crypto can be trusted, either. For many, the hope was that stricter regulation could restore confidence. But the FTX bankruptcy apparently derailed the legislation that Bankman-Fried had lobbied hard for. It had been opposed by some operators of DeFi platforms, who saw it as skewed against the interests of large, centralized exchanges like FTX. Tougher regulation could eventually make crypto a more stable and respectable investment. What is not clear is how much of the industry can withstand the kind of scrutiny that would entail.
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