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Crypto R.I.P.?

Cryptocurrencies are down for the count. Will they bounce back?

An advertisement for bitcoin in Hong Kong on Feb. 17. (Kin Cheung/AP)

Three and a half months ago, the hard-working staff here at Spoiler Alerts wrote a column about cryptocurrencies. I was, to put it gently, bearish: “One rule of thumb I have for asset bubbles is that if celebrities start getting in on the game, it might be time for the smart money to get out. Already some celebrities are being sued for promoting cryptocurrencies that turned out to be classic ‘pump and dump’ Ponzi schemes. This suggests that while crypto will not disappear, we have reached the bubble phase.”

A quarter of a year later, I’m sure everything has stabilized — wait, what does this New York Times story from last week say?

The price of Bitcoin plunged to its lowest point since 2020. Coinbase, the large cryptocurrency exchange, tanked in value. A cryptocurrency that promoted itself as a stable means of exchange collapsed. And more than $300 billion was wiped out by a crash in cryptocurrency prices since Monday.
The crypto world went into a full meltdown this week in a sell-off that graphically illustrated the risks of the experimental and unregulated digital currencies. Even as celebrities such as Kim Kardashian and tech moguls like Elon Musk have talked up crypto, the accelerating declines of virtual currencies like Bitcoin and Ether show that, in some cases, two years of financial gains can disappear overnight.
The moment of panic amounted to the worst reset in cryptocurrencies since Bitcoin plummeted 80 percent in 2018.

The decline of crypto echoes the decline in other risky asset classes like tech stocks — except, as the financial press has noted repeatedly, the crypto declines have been far more acute than even the recent losses in the S&P 500.

What is particularly damning about the recent crash is that an awful lot of tech boys who talked up crypto made the argument that cryptocurrencies were an excellent hedge against inflation. Inflation has undeniably increased over the past year and, well, that is when crypto crashed. As the Financial Times’s Scott Chipolina and Katie Martin noted, “Their performance has undermined claims that crypto assets can provide a hedge against inflation or behave as a form of digital gold — let alone the grander boasts of crypto partisans about the potential for digital tokens to become the pillar of a new global financial system.”

Furthermore, in an eerie echo of the 2008 financial crisis, one of the triggers for the market meltdown occurred when a comparatively “safe” investment — money market funds in 2008, stablecoins in 2022 — was not safe. Oops.

As a crypto-skeptic, it is tempting just go all Nelson Muntz on this situation. That would be uncharitable. Rather, it is worth considering whether the 2008 comparisons will go deeper. Can the collapse of crypto presage another financial crisis? This seems unlikely. The aggregate size of cryptocurrency markets is simply not large enough to lead to a general liquidity or solvency crisis.

Instead, the crises are real but more specific. El Salvador provides an excellent cautionary tale for other countries in the Global South. Last September, Salvadoran president Nayib Bukele announced that bitcoin would be accepted as legal tender. A month later he announced that his government had purchased $25 million in bitcoin. He persisted in embracing crypto despite warnings from bond rating agencies and the International Monetary Fund that this was a risky strategy.

Now El Salvador is in some financial trouble. El Pais reports that Salvadoran bonds are only trading at 40 percent of face value. Bitcoin has dropped more than 44 percent in value from the start of Salvadoran purchases, equal to their next bond payment. According to Bloomberg News, “Bukele, a devout believer in cryptocurrencies … has been trying for more than five months to sell a bitcoin-backed bond. But investors have soured on El Salvador’s bonds, concerned not only with the government’s ability to keep current on its debt but its willingness to do so.” One does wonder whether voters will start asking why Bukele is purchasing bitcoin rather than spending on things like schools or roads.

Another crisis will be the late entrants to crypto who cannot afford to ride out the market gyrations. Retail purchasers of crypto made their choice based on horribly skewed information. They are now paying the price for doing so.

What, if anything, will the government do in response? One has to expect that some regulation is coming. While cryptocurrencies have largely lobbied to advance their libertarian beliefs, it is striking how the crisis is causing some of them to embrace New Deal financial regulation.

Crypto has suffered crashes like this before. Boosters like Elon Musk and Jack Dorsey will probably be fine. Plutocrats sitting on billions of dollars possess the most valuable financial asset ever: the time and cushion to ride out vicissitudes in capital markets. This crash, however, will probably thwart their preferred outcome — more widespread acceptance of crypto in the financial markets — for quite some time.

The hidden upside: celebrities will finally shut up about crypto.