The non-fungible token (NFT) frenzy is burning itself out, algorithmic stablecoins are collapsing, and crypto lenders are going out of business. These phenomena are all related to the decentralized finance (DeFi) and centralized finance (CeFi) bubbles. Cryptocurrency prices are falling.
Crypto doubters often proclaim “the death of crypto.” But this type of rectification has been witnessed before. Indeed, many times. Upon the collapse of the Mt. Gox exchange in 2014, the price of bitcoin plummeted. Additionally, when hundreds of “initial coin offers” (ICOs) failed in 2018, the price of bitcoin dropped by 80%. In both situations, the market finally rebounded, and the price of cryptocurrencies increased. Even if bitcoin’s dollar value has decreased by 70% since last November, it still has a higher value than when it peaked in December 2017. So instead of waiting for the market to turn around, why not HODL?
But this time is really unique. An whole new macroeconomic paradigm is developing, driven by pandemic and conflict. After a 30-year hiatus, high inflation is returning, and with it, much stricter monetary policy. Central banks all around the globe are burning money as interest rates rise. The day when money was easy to get by is ending. And it will result in consistently decreasing cryptocurrency pricing.
Markets for cryptocurrencies have only ever known quick money. Following the 2008 financial crisis, many individuals believed that the experiment by central banks with ultra-low interest rates and quantitative easing (QE) would lead to uncontrollable inflation, which is when Bitcoin was created. Interest rates were remained much below levels seen before to the financial crisis ten years later, and central bank balance sheets continued to be greatly bloated. Additionally, the bitcoiners’ promised explosive inflation did not materialize. Instead, asset values had skyrocketed, including the value of cryptocurrencies, as investors flocked into bitcoin and other cryptocurrencies in search of returns.
From 2016 to 2018, there was a short period of relative dollar scarcity as a result of the Fed raising interest rates and spending money (quantitative tightening), as well as the issuance of bonds by the U.S. Treasury (which also burns fiat money). However, other central banks relaxed as the Fed tightened. QE just relocated across the globe; it never really came to an end. And the Fed resumed money injections in 2019 after dollar shortages disrupted the repo markets.
The epidemic followed. Central banks started the most extravagant money creation projects in history while governments shut down enterprises and gave money to individuals who couldn’t work. A large portion of the money ended up in the cryptocurrency markets, driving up prices to previously unheard-of heights and accelerating the development of high-yield loans, intricate synthetic assets, and hazardous derivatives similar to those last seen before to the 2008 financial crisis. There was a bitcoin feeding frenzy as the actual economy was shut down. Pension funds, hedge funds, software firms, football teams, and celebrities all participated in the scheme, and several regular individuals gained fortunes that changed their lives.
Since Bitcoin rose from the ashes of the financial crisis, and especially since March 2020, the cryptocurrency market has seen luxuriant development that is directly attributable to the abundant monetary fertilizer central banks have been dumping into the financial markets.
But inflation has since emerged. Whether this inflation is primarily the result of supply interruptions or excessive demand, and whether it will be short-lived or persistent, are topics of debate among economists. No big deal. Under pressure to reduce inflation, central banks are swiftly taking out the pruning shears and removing the monetary fertilizer. The most severe cutbacks will be felt in the markets with the most opulent growth.
Although it may be simple to see why the end of free money might be disastrous for individuals who invested in a highly leveraged crypto bubble, it is less clear why this is driving down the price of bitcoin. It seems sense that it would motivate individuals to invest heavily in deflationary cryptocurrencies like bitcoin. After all, some still believe that bitcoin will ultimately replace the dollar, which was its initial purpose. What better moment than the beginning of the inflationary Armageddon that will result in the end of the dollar’s status as the primary reserve currency of the globe to acquire and HODL the world’s future currency?
However, the majority of individuals who have recently purchased cryptocurrencies do not desire to do so. They do worry about its replacement. They desire to become financially wealthy. Therefore, stablecoins pegged to dollars are utilized in the majority of crypto transactions, cryptocurrency pricing are often expressed in terms of dollars, and dollar-pegged stablecoins are frequently used as secure collateral for cryptocurrency loans.
The dollar dominates crypto markets just as it does regular financial markets because to the strong ties the crypto ecosystem has made to the established financial system. The monetary worth of the cryptocurrency business has increased along with the growth of crypto marketplaces.
However, these dollars are fake. They only really exist in virtual spaces. The only organization in the world that has the ability to print actual money, the Fed, does not and has never guaranteed them. The Fed has absolutely no responsibility to make sure that folks who have earned significant sums of these “virtual dollars” may actually convert them to genuine cash. Therefore, when the crypto bubble pops, the “virtual dollars” just vanish. Your riches is just an illusion if you are unable to convert your virtual currency into actual cash.
The only real money spent in the bitcoin market is that which new participants pay when they make their first purchases. Stablecoins tied to the dollar supply the remaining dollar liquidity on cryptocurrency exchanges. These may be divided into two categories: those with backing in real money and/or secure liquid assets denominated in dollars, and those without. There aren’t enough of the first to allow everyone to cash out into real money, and there’s no assurance that any of the later will be able to be. As a result, all of the cryptocurrency market is partially reserved.
There is now a scramble to convert cryptocurrencies for the few remaining actual currency. The law of the jungle is in effect, as it always is in uncontrolled marketplaces. The money goes to the person with the largest teeth. Perhaps calling them “whales” is the incorrect term. Perhaps crocodiles would be a better fit.
The price of cryptocurrencies quickly drops to the point where there are enough dollars in the system for everyone to be able to cash out when everyone is seeking to convert their cryptocurrencies into more scarce dollars. That most likely translates to zero for derivatives and synthetics. Who will desire the derivatives, after all, if the price of the underlying assets is plummeting quickly? And synthetics aren’t genuine, as their name implies. Unreal things have no value when reality is on the fly.
Cryptocurrency won’t be able to increase once again as it has in the past if tighter money continues to exist, as many believe it will. Instead, it must adjust to the new paradigm. It may revert to its original form, do away with the dollar, and exclusively value cryptocurrencies in terms of themselves: “1 BTC Equals 1 BTC,” as bitcoin maximalists like to remind us. Instead than depending on network effects to inflate dollar values that are unrealistic in reality, it might instead attract more actual money by creating use cases that are applicable to the real world. However, it is doubtful that this will result in the high dollar values of the past.
There can be no return to the highly leveraged, fractionally reserved cryptocurrency system whose illusory riches are now giving way to real losses while the Fed is tightening monetary policy and there is neither a Fed guarantee nor Federal Deposit Insurance Corp. (FDIC) insurance for cryptocurrency deposits.
