I typically do not talk much about crypto, but you cannot ignore the growth of crypto over the last few years. It is also difficult to ignore the volatility of the crypto market lately. The volatility is so much so, that the dramatic downturn in crypto valuation are rising concerns of a total crypto crash.
What Is Crypto
If you do not know what crypto is, here is a simplified definition. Crypto currencies are digital currencies that are not reliant on any central authority. Crypto essentially is a digital currency that is not backed by a government or bank. While crypto is designed to be outside of the traditional financial system, it can be affected by the system.
Crypto Crash
Over the last few months, the crypto crash has wiped out an estimated $1.6 trillion. Coinbase has tanked in value. Bitcoin and Ether has also lost value. For the most part, much of the value gained over the last two years have disappeared. For example, Bitcoin has dipped below $28,000 after hitting a high of over $68,000. But one of the largest crash is that of TerraUSD.
TerraUSD
2022 has not been a great year for the stock market. The stock market has fallen, with some individual stocks dropping more than 70%. On the crypto side, one of the biggest losers in 2022 has been TerraUSD, one of the largest stablecoins. As a background, TerraUSD was intended to be pegged to the U.S dollar. TerraUSD was backed by credible venture capital firms, but not backed by cash, treasuries or other traditional assets. The supposed stability of TerraUSD was derived from algorithms that linked its value to the cryptocurrency called Luna.
The aim was to use algorithms to peg TerraUSD to the U.S dollar. Essentially, minting $1 of TerraUSD requires burning $1 worth of Luna and vice versa. So, as TerraUSD demand increase and its value goes above $1, to bring the value down, Luna would be exchanged for TerraUSD to increase TerraUSD’s supply to bringing the value down. The reverse would be used to increase TerraUSD’s value where low demand lowers its value. However, TerraUSD had a known issue, the possibility of a death spiral.
With large dumping of Luna on the market, Luna began to lose value as supply became inflated. This resulted in more Luna being minted for each TerraUSD burned. This in effect caused a death spiral effect on TerraUSD. As Luna’s value fell, investors panicked and sold off their tokens. This action further fueled the death spiral, until Luna went to $0 from a value of $116. It is estimated that this crash wiped out about $40 billion.
The Real World & Crypto
Just as the stock market is affected by the traditional financial system, so is the crypto market. The current crypto crash is part of a broader pullback from risky assets. This pullback has been driven by rising interest rates and regulatory policies to tighten the monetary supply, inflation and economic uncertainty caused by Russia’s invasion of Ukraine. With interest rates rising, savings accounts are becoming more attractive to many. Many investors are taking profits and pulling money from the stock market and putting it where they can get predictable returns.
Additionally, as the stock market falls, some investors are liquidating crypto investments to meet other obligations. This all comes together to drive crypto prices lower which causes further panic in the crypto ecosystem. Another factor that is affecting the crypto ecosystem is the increase scrutiny being placed on crypto by governments around the world. There is more and more calls for increase regulation.
Long Term View
As the crypto crash continues, it is expected that a lot of different crypto currencies will fail, while others will succeed. This is not the first time that crypto has fallen. Do not forget that in May 2021 to July 2021, crypto also had extreme volatility where Bitcoin fell more than 45%. For those investing in crypto for the long term, massive price swings are expected.
Conclusion
As crypto continues to grow, it cannot be ignored. Whether you make crypto apart of your portfolio is a decision that you should not take lightly. As the crypto crash of 2022 rolls on, no matter the instrument, do not invest in things you do not understand, and invest only what you can afford to lose.
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