Cryptocurrencies: Carnage's Anatomy

Cryptocurrencies: Carnage’s Anatomy

#Cryptocurrencies #Carnages #Anatomy

The value of all cryptocurrencies has fallen in recent days. A movement that, due to its magnitude, recalls the darkest hours in the history of bitcoin, but whose singularities can make it a particularly painful episode for the economy.

Two hundred billion dollars disappeared in 24 hours, the site CoinMarketCap, which follows the evolution of cryptocurrencies, calculated on Thursday, May 12. The latter are currently going through a zone of very strong turbulence, registering repeated losses that seem to have no end.

The queen of them, bitcoin, went from a value close to $60,000 per bitcoin at the end of 2021, to a value of just over $30,000 on Friday, May 13. The same goes for all these dematerialized coins whose total capitalization has halved over the same period.

Blame the Federal Reserve

“For anyone panicking, here is a list of phone numbers for moral support services,” read one of the many cryptocurrency subforums on the popular community site Reddit.

“There is a clear debacle currently in this sector,” acknowledges Nathalie Janson, 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 seventh heaven. Thus, just a year ago, “during the same period, bitcoin had lost 50% of its value after China’s decision to limit the use of this currency,” recalls this expert.

She points out that each of these brutal price corrections had a “logical reason for happening,” whether it was a political decision by Beijing or the backlash of overenthusiasm from investors like during the first “crypto winter,” in 2017.

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The descent into hell in 2022 is no exception to this rule. This time, the US Federal Reserve would be to blame. Cryptocurrencies are reacting, in fact, like the rest of the technology stocks that had a disastrous start to the year due to the decision of the US Fed to raise interest rates.

“When interest rates rise, less risky investments that depend on these rates, such as bonds, yield more, which can lead investors to abandon riskier investments such as cryptocurrencies”, summarizes Nathalie Janson.

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

Terra, the stablecoin that destabilizes everything

Furthermore, there is a crisis within the crisis. An important part of the entire ecosystem has begun to malfunction. “Terra cryptocurrency outages accelerated the price decline,” says Nathalie Janson.

What is it about ? Terra is what is called a stablecoin, that is, a cryptocurrency whose price, unlike the vast majority of its sisters, (almost) does not vary. It is even one of the largest, behind Tether, which is worth 80 billion dollars. These stablecoins accomplish this by generally being pegged to a “real” currency, such as the dollar.

For Terra it is a bit different: it is not attached to another currency but it is a complex algorithm that ensures that its course does not deviate from 1 terra = 1 dollar…. in theory.

Except that in practice, the price of this stable coin fell to almost 20 cents at the beginning of the week. An unprecedented fact linked to a mystery: “Terra’s reserves rose on Friday, May 6, from 14,000 million dollars to 9,000 million dollars, without anyone really knowing who withdrew all this money,” says Nathalie Janson.

But whoever is to blame: Investors saw it as a sign that something was wrong in the realm of this stablecoin. Then they also started to get rid of their Terra, accelerating the fall of this cryptocurrency.

We then started talking about the “Lehman Brother” moment of stablecoins, referring to the collapse of Lehman Brother bank in 2008 that led to the cascade of bankruptcies of other institutions. A contagion phenomenon also seems to have started operating in the world of cryptocurrencies, as even Tether briefly lost its peg to the dollar on Thursday, May 12.

The first crisis of the era of the democratization of cryptocurrencies

For the ecosystem as a whole, the malfunction of these stablecoins could be fatal. In fact, exchanges from a cryptocurrency to a currency such as the dollar or the euro always go through a stablecoin first. He is a bit of an intermediary who reassures everyone by providing stability.

If no one trusts Terra, Tether and so on, there will simply be no more trading in the cryptocurrency market, which is worth $1.3 trillion anyway and is invested in by pension funds, the biggest banks and idealistic geeks . Ironically, this is one of the systemic risks to the sector highlighted by the Global Financial Stability Board in a report published in February 2022.

Finally, this crisis is unprecedented in terms of the magnitude of the losses caused to ordinary mortals. This is the first price drop in the era of “democratization of cryptocurrencies”, underlines Nathalie Janson. Two or three years ago, only insiders invested in this type of asset. Today, Reddit forums and most articles discussing this deadly spring for bitcoin are filled with testimonials from people who “lost all their life savings.”

A sad reality that is explained by the avalanche of small investors on the Stock Market on Sunday during the pandemic. Often young and highly connected, they often turned to cryptocurrencies that seemed to carry out ambitious projects while offering very attractive interest rates.

“There are a good number of students today who, to pay for part of their studies, have invested in these assets,” says Nathalie Janson. For them, it is a whole world that threatens to collapse with this crisis.

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