The Big Picture

Vincent Boland: Why the crypto crash was a calamity waiting to happen

Hyped and marketed to a ridiculous extent by its backers, the $2.5 trillion virtual ‘currency’ segment of the market was always going to collide head-on with reality. The question is: what happens next?

Do Kwon, co-founder and chief executive officer of Terraform Labs: his $40 billion cryptocurrency Luna collapsed last month. Picture: Bloomberg

When a $2.5 trillion segment of the financial industry runs into trouble, one would expect governments, institutions and central banks to be braced for the fallout and the world to be sitting up and taking notice. But amid war, inflation and a cost-of-living crisis, the meltdown in the cryptocurrency world of the past few weeks seems like a sideshow. It could turn out to be a lot more than that.

We are familiar with the bubble which occurred in asset prices during the pandemic, when stock markets doubled in value and the price of everything, from art to property, soared even as the global economy was in hibernation. The biggest bubble was in the crypto universe, where values rose tenfold between the start of 2020 and its peak last November. Now this bubble is deflating at an astonishing rate. Many investors have lost their savings, thousands of jobs have been shed, and reputations have been shredded.

The crypto universe – bitcoin and its iterations among the many thousands of cryptocurrency offerings on the market – was worth about $2.5 trillion at the end of last year, according to the International Monetary Fund. Bloomberg estimated it was worth $3 trillion. Now, according to multiple reports, that value has tumbled below $1 trillion. The price of bitcoin, the benchmark cryptocurrency, fell below $20,000 per coin last weekend, compared to $55,000 in November, though it has recovered a little in the past few days.

Luna, a $40 billion cryptocurrency created by a South Korean entrepreneur named Do Kwon, collapsed last month, wiping out all its investors, who included 280,000 Korean citizens, according to official data cited by the Financial Times. (Investors in Luna called themselves lunatics.) The authorities in Seoul have slapped a flight ban on some employees of Luna and launched an investigation into Terraform Labs, Kwon’s company. The US Securities and Exchange Commission is also on his case.

A couple of hedge funds are in trouble, and trading platforms have announced that they are shrinking back amid signs of a credit crunch. Regulators are beginning to crack down on the crypto world. Still, some crypto evangelists remain in denial. One is Nayib Bukele, the president of El Salvador, the only country where bitcoin is legal tender. He has invested some of his country’s scarce cash in bitcoin, and he tweeted last week that anybody worried about the price should “stop looking at the graph and enjoy life”.

Whatever about the unfortunate people of El Salvador, this is a key moment in the emergence of the crypto universe. The meltdown has not just cost investors billions of dollars; it has undermined many of the outlandish claims about cryptocurrencies made by their boosters and cult-like followers, including that it is the future of finance. The notion that an “asset” as opaque and difficult to value as crypto would make capitalism more accountable and democratic, and perhaps even replace banks as repositories of people’s cash, was always nonsense. It was part of the deliberate mystification of crypto, which is almost as much of a cult as it is a segment of the financial system.

The meltdown exposed another myth about cryptocurrencies: that they are an asset class apart, unrelated to any other asset class because of their unique structure and properties. This is also nonsense. The crypto price collapse is closely related to the fall in the price of technology stocks, which has seen the Nasdaq stock market tumble by at least a third since the beginning of the year. Crypto, it turns out, is not a universe unto itself.

Many of the problems that now beset crypto are of its own making. One is that it is drowning in oceans of hype and marketing more extreme and lavish than the hype that engulfed the dot-com era at the turn of the millennium. The language in which cryptocurrencies are discussed by advocates tends to mystification, in which the simple is rendered complex and the complex is simplified.

Another is that cryptocurrencies are not what the second part of that name implies – currencies. Any currency that is legal tender has three unique qualities. It is a medium of exchange, a store of value and a unit of account. Crypto is not a medium of exchange; it is an asset that can be exchanged between a buyer and a seller, which is not the same thing. You can buy things with crypto, but it is not money in the accepted sense because it has no intrinsic value. The economist Eswar Prasad, a senior fellow at the Brookings Institution, a think tank in New York, describes cryptocurrencies as “virtual objects that are nothing more than computer code”.

Surveys by the IMF indicate that many investors are based in emerging market and developing economies. Cryptoisation, as the IMF calls the phenomenon, is driven by “weak central bank credibility, vulnerable banking systems, inefficiencies in payments systems and limited access to financial services”. This suggests those who will be worst affected by the crypto meltdown will be poor people in poor countries. This is another troubling aspect of the current crisis in the market.

Some observers have called the crypto meltdown the industry’s Lehman Brothers moment, after the Wall Street investment bank whose collapse triggered the global financial crisis. Perhaps it is, though there is no single institution in the crypto universe as entangled in the industry as Lehman was in banking. But if the contagion keeps spreading, and if, as the IMF says, many of those at greatest risk of losing their money are in developing countries, then it is possible that the global impact of the price falls will be severe.

In the longer term, the shakeout matters, because the digitisation of currencies is almost certain to happen. Central banks have been cautious so far in their approach to cryptocurrencies. But some are pursuing a digital version of their national currencies regardless. That makes sense. Big Finance is so overbearing and outsized that it is no longer a truly competitive or innovative industry. Financial exclusion is a fact across the world, and the global payments system is expensive and bureaucratic.

Any “asset” built on hype, mystification and computer code was always going to have a head-on crash with reality. They are barely a decade old, but cryptocurrencies are in need of reinvention. The meltdown could be the start of that.

Emmanuel Macron, the French president, will have his work cut out forming a new government following the recent parliamentary election results. Picture: Getty

While France weighs up the options, Italy’s centre gets its act together

There were two minor political earthquakes in Europe last week, and one of them matters more than the other.

One was in France, where Emmanuel Macron lost his political majority in parliamentary elections a few weeks after he won re-election to the Élysée palace by a wide margin. The outcome means the French president will have a hard time cobbling together a government from a National Assembly in which no single party or grouping of parties has a clear majority.

La Republique En Marche, Macron’s centrist movement, and its allies have the most seats, but too few to form a government. The left-wing NUPES coalition is in a similar position. There is talk, much of it abroad, that France is ungovernable. This is nonsense. The country is divided on social issues, and Macron hates to compromise. A period of coalition now beckons. Other countries do that perfectly well, and there is no reason why France won’t.

The political earthquake that reverberates, and will have medium-term consequences that might work in Europe’s favour, happened in Italy. The Five Star Movement, a partner in prime minister Mario Draghi’s government, is starting to disintegrate. M5S, as it is often known, was founded by the comedian Beppe Grillo and emerged as a disruptive force in Italian politics in the past decade.

Last week it split, as all disruptive comedy acts – sorry, I mean political forces – are destined to do, and the trigger is the war in Ukraine. Italy has long been close to Russia, reflecting anti-American sentiment among Italian voters and Italy’s dependence on Russian energy. Draghi has placed Italy firmly on Ukraine’s side in Vladimir Putin’s monstrous war, offering military aid to Kyiv and backing its EU ambitions.

Draghi’s stance has caused ructions inside M5S, parts of which nurture the movement’s anti-Nato stance. But Luigi Di Maio, a senior M5S figure who is Italy’s foreign minister, strongly backs Draghi, and he announced last Tuesday, after weeks of tension, that he was leaving the party along with at least 60 of its MPs to set up a new parliamentary grouping and stay in government.

A political upheaval in Italy often sends shivers through the bond markets, and Italian government bonds have been weakening, along with those of other fragile eurozone economies, in the market turmoil of the past few weeks.

But the financial reaction to the ongoing implosion of M5S was muted. This makes sense. Di Maio’s move strengthens rather than weakens Draghi’s government, and is the first step in reshaping the political landscape ahead of parliamentary elections that must be held within a year. The centre ground in Italian politics seems to be getting its act together. That is good for Italy, and for Europe.