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Crypto Economy Relives a Bit of Ugly Financial History

Crypto Economy Relives a Bit of Ugly Financial History

June 13, 2022

Investment markets have certainly been ugly this year. 

We have stocks in bear market – the S&P 500 is down 20% year to date.   That is due to worries about inflation taking a bite out of corporate profits, as well as the impact of higher interest rates (which can drive down stock valuations). 

Bonds are supposed to help portfolios during difficult markets, but rising interest rates have driven the bond market index down by over 10% year to date. 

But this is a run of the mill bear market.  Nothing out of the ordinary.  We will get through this the way we always do with patience and prudence.  Stocks went down by 20% in fall of 2018, fell by 38% during the pandemic scare, and lost over 50% of their value in the financial crisis.   The market seems to be predicting an oncoming recession, despite a currently strong (even overheating) economy.  In an average recession, stocks will fall by 30% then typically come back strongly with the eventual recovery (even though the full cycle may take 12-30 months to unfold).   

If this all seems a bit gloomy, consider what is going on in the “crypto” markets.   Given that a large share of the world’s crypto is held by international criminals, rogue regimes, and drug traffickers, I think I am entitled to a bit of schadenfreude as the crypto universe implodes. 

For those who don’t pay attention to crypto – first good for you.  Over the past few years, an entire parallel financial industry sprang up, built around cryptocurrencies.  You had what were essentially “crypto banks” making crypto loans and taking in crypto deposits.   You had so-called “stable coins” which were digital tokens which promised to always be worth $1.   All of this completely unregulated.   “Money” was supposedly being created out of thin air.  

Well, we all know what happens when you allow the financial and banking industry to operate without any regulation.  The crypto industry promised a libertarian nirvana = “power to the people” “no need for banks” etc etc.  What they gave those who fell for their schemes and empty promises is what is starting to look like a crypto version of 1929, complete with bank runs and closures.. 

First the “stable coins” failed to be “stable”.   A popular stable coin dramatically failed recently, becoming worthless almost overnight.  Now a major “crypto bank” (I use quotes because although it acts like a bank, it is not subject to any banking regulation) appears to be failing.  The crypto lender Celsius (one of the biggest crypto lenders) has frozen withdrawals from customer accounts due to what appears to be the digital version of a good old fashioned bank run.  At one point it promised interest payments to depositors as high as 18% - now those depositors are finding that a) they can’t get their money out and b) there is no FDIC insurance and c) if the “bank” fails, they will lose everything.  Bitcoin has lost 2/3 of its value over the past few months and other cryptocurrencies have fared even worse. 

So, for those who think that crypto is the answer to a “failed and corrupt” financial system, consider that it only took a few years for the greed of an unrestrained crypto market to recreate the speculative excesses and crash of 1929.   Those who ignore the hard lessons of history are doomed to repeat them, right?    

I believe that the excesses of the crypto market have contributed a lot more than is widely appreciated to the excessive demand that is fueling inflation in the “real economy” that the rest of us have to live in – so the sooner this speculative bubble deflates the better for the rest of us!   

As for the “real economy”, traditional banks are thoroughly stress tested by the Fed and have record high levels of liquidity and capitalization due to much tighter capital requirements implemented after the 2008 financial crisis.   That is not credit to the banks – rather credit is due to a regulatory framework and system which has been built up and strengthened over the years to avoid and prevent the excesses of the past.  Due to much stronger banking regulation, any recession that we experience now will not likely be exacerbated by financial institution failures such as we experienced in 2008.