People who put their hard-earned cash into a tumbling cryptocurrency unit that is at the heart of the latest sharp decline in digital coins may be regretting they did not read a recent paper by Canadian financial technology scholar Ryan Clements demonstrating why it was bound to fail.
In fact, all investors who have piled into any crypto assets since the end of 2020 and have not already sold may be feeling remorse for failing to take Clements’s comments in my last column on cryptocurrency as a word to the wise. Most will be deeply under water: In other words, their investments will be worth a lot less than they paid for them.
“I’m not sure … that people knew what they were getting themselves into,” Clements said on Thursday as he surveyed the damage on his computer screen.
Now, other financial commentators are echoing his warning that this time, the loss of more than a trillion U.S. dollars in asset value from world cryptocurrency markets will have an impact well beyond the “crypto bros” who put in their own money.
Clements, a securities lawyer who now teaches at the University of Calgary and advises Canadian securities regulators, said that does not mean the most popular crypto assets may not rise again. They have done it before.
But as Canadians who still hold a stake wait to see what Friday the 13th will do for asset values, Clements said the past week’s crypto sell-off has settled a few questions. One is whether, like gold, the limited supply of the most important cryptocurrencies means they are a hedge against inflation or against the decline of other risk assets. We now know they are not.
As inflation has climbed and markets have declined, even the best-known crypto token, bitcoin, was trading down nearly two-thirds from its peak of $69,000 in November of last year.
“Crypto assets are risk assets, they’re not stable assets, they’re not stores of value,” Clements said. “And so that’s why we’re seeing a general market sell-off.”
Anyone who took the advice of film star Matt Damon last October — “Fortune favours the brave” — in his promotional video for Singapore-based Crypto.com may be lamenting their courage.
Perhaps ironically, one of the destabilizing features of the current crypto decline this time is related to what are known as “stablecoins,” which despite their name have put the entire market on edge.
As London’s Financial Times warned on Thursday, another difference this time is that traditional markets could suffer from the crypto meltdown.
“Unfortunately, even those fund managers in normal markets like stocks and bonds who have studiously avoided focusing on this freewheeling asset class need to pay attention,” wrote the paper’s markets editor, Katie Martin.
There were reports on Thursday that El Salvador, which has accepted bitcoin as legal tender, had lost $40 billion US — enough for the cash-strapped Central American country to cover its next bond payment — and credit rating agencies warn of an increased risk of default.
Already, on Thursday, conventional market shares of the company Coinbase, which runs a platform for trading digital tokens, had lost half their value on the week. And as Canadians tally up their bitcoin losses or sell to escape further losses, they don’t feel so rich anymore.
“Any time there is massive selling in a segment of the market, there can be flight to safety and a cascade of selling across other assets,” Clements said, describing potential contagion that can lead to systemic risk.
An example of contagion is the sharp decline in terra, one of the so-called stablecoins that, unlike other kinds of cryptocurrency, aren’t supposed to rise and fall but should stay pegged to the U.S. dollar, to be used as a dollar substitute on digitized global markets.
On Thursday, terra was “officially halted” for two hours, said the company, Terraform, which runs the crypto unit’s blockchain — the software that sets a cryptocurrency’s value and reveals who owns each of the units. Before activity was halted, the value of the unit had plummeted as low as 23 cents.
It was terra that Clements warned about in a widely quoted paper titled Built to Fail, which focuses specifically on what are called “algorithmic stablecoins” — of which terra is the most important example and of which he predicted faced catastrophe.
“Its catastrophic failure, I think, has contributed to the larger crypto sell-off,” Clements said.
He is not the only one who takes that view, Nor is Clements the only one who thinks some cryptocurrency units could eventually rebound. But he sees more potential trouble ahead.
Now that the tokens have shown themselves not to be an inflation hedge, a major justification for holding them — as outlined to me earlier this year by Henry Kim of York University’s Schulich School of Business — may have disappeared. As a risk asset, not money or an innate store of value, crypto should perform more like tech stocks but without any underlying income, falling as inflation and interest rates rise.
Sharper declines could lead to forced sales for those who have borrowed to buy. Clements is convinced some of the 19,419 crypto examples now listed on CoinMarketCap will fall to zero or worse. He also fears some crypto examples will prove to be blatant frauds.
Clements says that as crypto units test new lows, now may be the time to reassess the purpose and value of cryptocurrency and the energy-intensive global software that keeps them all alive.
“I think its a neat time in the market to find out what is the true utility in blockchain,” he said. “Other than just crypto for the purpose of speculative trading.”