Investors fall back on aphorisms in every financial cycle. Think of "Buy on the rumour, sell on the news" or "Markets can be irrational longer than one can be solvent". Those sayings have staying power because they often have a tinge of credibility. Today, amid the general market downturn, cryptocurrency assets are plummeting in value, and the aphorism of the moment is "When the tide goes out, you see who's swimming naked."
The fall of cryptocurrencies has been enormous. In November, the value of that market was nearly $3 trillion. In mid-April it dropped to $2 trillion, then plunged another 35% to the current $1.3 trillion. Bitcoin briefly dipped below $29,000, its lowest since late 2020. Cryptocurrency detractors have long argued that they are worthless (unless someone is a money launderer or scammer) and have predicted their disappearance. The fall will convince many that they are right. In reality, the picture is quite different: a selection process is taking place in which the most dubious parts of the crypto world are exposed while others prove to be more resistant.
The cryptocurrency crash is part of that broader crash. Red-hot inflation is forcing central banks to tighten monetary policy, prompting a sale of riskier or longer-dated assets. After a strong sell-off on May 18, the Nasdaq tech index is down 29% from its high. The S-Index
However, cryptocurrencies top the list of speculative assets taking the biggest hits. Sales have revealed weak points. Consider terra, an "algorithmic" stablecoin, whose value is backed by another asset, which supposedly makes it trustworthy. On paper, users could exchange $1 of terra for $1 of another cryptocurrency, luna, which would be issued to meet demand. However, the price of moon started to drop in early May, putting pressure on the terra peg. There was a rush to redeem. Luna's supply skyrocketed and its price plummeted. On May 10, there were 350 million moon tokens in existence; now there are 6.5 billion. At its peak, Luna was worth $40 billion and backed $18 billion of Terra. Now it's worth nothing, and terra is worth 10 cents. In retrospect, the plan seems crazy.
At the other end of the spectrum is USDC, a stablecoin backed by cash and short-term Treasury bills that publishes monthly audited financial statements. He has done well. The same goes for dai, another cryptocurrency-backed, algorithm-driven stablecoin. Dai has a reasonable degree of transparency and maintains at least 1.5 times more backup than it needs. The supply of the cryptocurrencies on which it is based (USDC and ether) is controlled independently.
In the middle of those two extremes is Tether, the largest stablecoin, which briefly fell below its face value of $1 per token on May 12. The cryptocurrency claims to be backed by assets including cash, Treasuries and corporate debt, but the information is dismal. Tether refuses to reveal the exact mix of assets, claiming it is its "secret formula." She has already been fined by the New York attorney general for misleading investors. With the market selling intensifying in recent weeks, its holders have been nervous, and rightly so. Since being unpegged, Tether holders have redeemed some $9 billion worth of tokens, about 10% of the total.
Investors are doing what they are supposed to be doing: penalizing instruments that are fundamentally flawed or issued by poorly managed organizations. However, the sale has sparked renewed calls for the government to intervene. Consumers are at risk of being scammed. And the volatility could spread to the conventional financial system. For example, Tether is a critical part of the crypto pipeline and the most liquid base currency for trading between other crypto assets, as well as between cryptocurrencies and conventional currencies. If it failed, the consequences would be greater.
Some critics want to ban the cryptocurrency system; others want it to be heavily regulated, like banks; others want it to be regulated, but fear it will be interpreted as official endorsement. The problem is that the draconian measures would jeopardize the benefits promised by cryptocurrencies, such as new financial products that avoid the rigidity of banks, innovations in property rights and the possibility of a less centralized financial system.
So what should governments do? The best way would be to speed up the selection process that is underway. The key to this is more reliable information so that retail users and institutions can more effectively protect themselves against fraud. In particular, stablecoins should be forced to reveal their backing: what the assets are, where they are and who controls them. Some cryptocurrency companies based outside the United States are not within the purview of their regulators; however, Uncle Sam could require large US cryptocurrency exchanges, which are already regulated, to indicate which tokens have met reporting standards. The phrase that now comes to mind is: "That helps the market separate the wheat from the chaff."
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Translation: Juan Gabriel López Guix
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