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 invariably proclaim “the death of crypto.” But this kind of rectification has been witnessed before. Indeed, several times. Upon the collapse of the Mt. Gox exchange in 2014, the price of bitcoin plummeted. Additionally, as 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 though 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?
Frances Coppola writes a column for CoinDesk and speaks frequently on topics related to banking, finance, and economics. She promotes “helicopter money” to bring economies out of recession in her book, “The Case for People’s Quantitative Easing,” which describes how modern money production and quantitative easing function.
But this time is actually unique. An entirely new macroeconomic paradigm is developing, driven by pandemic and conflict. After a 30-year absence, high inflation is returning, and with it, much stricter monetary policy. Central banks all over the world are burning money as interest rates rise. The day when money was easy to come 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 still much below levels seen prior to the financial crisis ten years later, and central bank balance sheets continued to be greatly inflated. 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 yield.
From 2016 to 2018, there was a brief 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 loosened as the Fed tightened. QE simply relocated across the world; it never truly came to an end. And the Fed resumed money injections in 2019 after dollar shortages disrupted the repo markets.
The pandemic followed. Central banks started the most extravagant money creation projects in history as 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 lending, intricate synthetic assets, and toxic derivatives similar to those last seen prior to the 2008 financial crisis. There was a bitcoin feeding frenzy while the actual economy was shut down. Pension funds, hedge funds, software firms, football clubs, and celebrities all participated in the scheme, and numerous regular people made fortunes that changed their lives.
Since Bitcoin rose from the ashes of the financial crisis, and especially since March 2020, the cryptocurrency market has experienced 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 cuts will be felt in the markets with the most opulent growth.
Although it may be simple to understand why the end of easy money could 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 people to invest heavily in deflationary cryptocurrencies like bitcoin. After all, some still believe that bitcoin will eventually 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 those 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 thanks to the strong ties the crypto ecosystem has made to the established financial system. The dollar value of the cryptocurrency business has increased along with the growth of crypto markets.
However, these dollars are fake. They only actually 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 wealth is only an illusion if you are unable to convert your virtual currency into actual cash.
How I Made It: From a Pro Baller to a Master of DAOs by David Z. Morris
The only real money spent in the bitcoin market is that which new participants pay when they make their initial purchases. Stablecoins tied to the dollar provide the remaining dollar liquidity on cryptocurrency exchanges. These can be divided into two categories: those with backing in real money and/or safe 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 currently a race to convert cryptocurrencies for the few remaining actual currency. The law of the jungle is in effect, as it always is in unregulated markets. The money goes to the person with the biggest teeth. Perhaps calling them “whales” is the wrong 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 increasingly 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 real, as their name implies. Unreal things have no value when reality is on the flight.
Cryptocurrency won’t be able to rise once more 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 might revert to its original form, do away with the dollar, and exclusively value cryptocurrencies in terms of themselves: “1 BTC = 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 unlikely 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.
