Cryptocurrencies: Anatomy of a Carnage

All cryptocurrencies have fallen in value in recent days. A movement by its size marks the darkest hour in bitcoin’s history, but its singularities can make it a particularly painful episode for the economy.

Two hundred billion dollars went up in smoke in 24 hours, calculated Thursday 12 May CoinMarketCap, which tracks the development of cryptocurrencies. The latter is currently crossing a very intense turbulence area, recording recurring losses that seem endless.

The Bitcoin Queen went from a value of nearly $60,000 a bitcoin at the end of 2021, to a value of just over $30,000 on Friday, May 13. The same for all these immaterial currencies whose total capitalization was halved during the same period.

Blame the Fed

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

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

She notes that each of these brutal price corrections had a “reasonable reason for them to occur,” whether it was a political decision from Beijing or a backlash from provoking a lot of investors as happened during the first “crypto winter,” in 2017.

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Descent to Hell in 2022 is no exception to this rule. This time, the US Federal Reserve will be in charge. Cryptocurrencies, in fact, are reacting like the rest of the tech stocks that had a disastrous start to the year due to the US Federal Reserve’s decision to raise interest rates.

Natalie Jansson sums up: “When interest rates are high, lower-risk investments that depend on these rates – such as bonds – generate higher returns, which can lead investors to abandon higher-risk investments such as cryptocurrencies.”

But in many ways, the big drop in bitcoin is also out of the ordinary for the currency’s traditional yo-yo effects. First, because the Fed hasn’t finished raising interest rates. It will continue to do so as long as it deems it necessary to combat inflation. Unlike previous crises, this is not a one-time event that investors simply need to adapt to and then allow the price of Bitcoin to rebound to new highs. The downtrend this time may last longer and turn deeper.

Tera, the stablecoin that destabilizes everything

Moreover, there is a crisis within the crisis. An important part of the entire ecosystem is beginning to fail. “The Terra crypto turmoil has accelerated the price decline,” says Natalie Jansson.

What is it about? Terra is the so-called stablecoin, that is, a cryptocurrency whose price (almost) does not differ, unlike the vast majority of its sisters. It’s even one of the largest, behind Tether, which is worth $80 billion. These stablecoins achieve this by generally pegging them to a “real” currency, such as the dollar.

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For Terra, it is a little different: it is not tied to another currency but is a complex algorithm that ensures that its path does not deviate from 1 tera = $1…. theoretically.

Practically speaking, the price of this stablecoin has dropped to nearly 20 cents at the start of the week. An unprecedented event connected with a mystery: “Terra reserves rose on Friday May 6 from $14 billion to $9 billion, without anyone really knowing who pulled all that money,” notes Natalie Janson.

But whoever the culprit: Investors saw it as a sign that something was wrong with the kingdom of this stablecoin. Then they started dumping Terra as well, accelerating the downfall of this cryptocurrency.

Then we started talking about the “Lehman Brother” moment in the stablecoin, referring to the collapse of Lehman Brother Bank in 2008 that led to back-to-back bankruptcies of other institutions. It also appears that the contagion phenomenon has started to kick in in the cryptocurrency world, as Tether briefly lost its parity with the dollar on Thursday, May 12.

The first crisis in the era of democratization of cryptocurrency

For the ecosystem as a whole, failures in these stablecoins can be fatal. In fact, exchanges from a cryptocurrency to a currency such as the dollar or the euro always pass through a stablecoin first. It is a kind of broker that reassures everyone by providing stability.

If no one trusts Terra, Tether, and others, there will be no more transactions in the $1,300 billion cryptocurrency market in which pension funds, the biggest banks, as well as perfect geeks have invested. Ironically, this is one of the systemic risks to the sector identified 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 to ordinary human beings. This is the first price drop in the era of the “democratization of cryptocurrencies,” assures Natalie Jansson. Two or three years ago, insiders only invested in this type of asset. Today, Reddit forums and most articles discussing this killer Bitcoin spring are filled with testimonies of individuals who “lost all their life savings.”

A sad reality explained by the rush of small investors to the stock market on Sunday during the pandemic. Often young and very connected, they often turn to cryptocurrencies, which seem to carry ambitious projects while offering very attractive interest rates.

“Today there are a large number of students who have invested in these assets to pay part of their studies,” says Natalie Jansson. For them, the whole world is threatened with collapse with this crisis.

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