Jakub Porzycki/NurPhoto via AP
The cryptocurrency Terra LUNA has fallen in value by 99.99 percent in a week.
Cryptocurrencies are in trouble. At time of writing, all the biggest ones—Bitcoin, Ethereum, XRP, and Solana—were down by double-digit percentage margins just in the last 24 hours. Bitcoin is down by 58 percent from its high late last year; Ethereum is down 60 percent. The crash has wreaked economic havoc among gullible retail investors who bought into the hype—Reddit forums are filled with stories of people who have lost their life savings and are contemplating suicide. El Salvador, whose crackpot president tied his whole country’s economy to Bitcoin, is likely to default on its debt.
Even more troubling is what’s happening with Tether, a so-called stablecoin that is supposed to be “pegged” to the U.S. dollar, yet was knocked off its peg briefly on Wednesday, falling to 95 cents for a short time. If Tether were to collapse, and there’s every reason to think that it’s just a matter of time, it would take out most of the entire cryptocurrency ecosystem with it.
The situation lends powerful evidence to what crypto skeptics have been saying for years: The whole thing is a steaming pile of garbage. Crypto, NFTs, and all the rest of the “Web3” nonsense serve no legitimate purpose other than as an object lesson in the dangers of unregulated financial speculation.
Let me start with Tether, because it is sort of akin to what AIG was in the 2008 financial crisis—a big central institution that has spread systemic risk throughout the crypto ecosystem. One Tether is always supposed to be worth one dollar because the company has real assets backing them. Right away, this cuts against crypto ideology, which is supposed to be decentralized and outside of traditional banking notions. But investors have loved stablecoins, because they provided a handy way to speculate on various crypto assets. It can be hard to buy cryptocurrencies with dollars, because regulated banks are leery about working with crypto exchanges, but if you just buy Tethers first you can gamble all you want.
When you peer under the hood of Tether, as Zeke Faux did for Bloomberg Businessweek last year, you find just about the sketchiest business it is possible to imagine. It was co-founded by a former child actor with a minor part in The Mighty Ducks. Its principal bank partner is a D-tier Bahamian firm whose chairman co-created Inspector Gadget. It doesn’t produce regular, audited financial statements, it virtually certainly does not have $87 billion in good assets to back the Tethers in circulation, and Faux found it speculating with the assets it does have—and in incredibly risky stuff like Chinese commercial paper. On top of that, it’s under investigation by the federal government for alleged bank fraud.
All this makes it a bank run waiting to happen. Once that confidence is lost and people start trying to cash out en masse, Tether will bleed through its assets, the peg will break, and its value will collapse. Tether falling off its peg on Wednesday and then slowly recovering sure looks like it is going through the second step in the process. Anyway, even if it did have $87 billion in good assets, it would still be vulnerable to a run, because if one got going it would have to conduct an fire sale at bargain prices.
Once that happens, it would be a body blow to crypto trading of every kind—and might even cause damage to the real economy, since many financial firms have gotten into the game.
But perhaps the most illustrative crash, in terms of what it reveals about the crypto mindset, is what happened to the Terra LUNA system. TerraUSD is an “algorithmic” stablecoin, meaning it tried to engineer around the functional challenges of stablecoins (especially the need for real asset backing) through computer programming. In theory, one TerraUSD would always be worth one dollar because whenever its price fell below $1, traders could erase a Terra in exchange for $1 in new Terra LUNA (a totally different coin), while if the price rose they could make the opposite transaction, thus providing an incentive to keep it pinned.
The key thing here is that TerraUSD price was kept up by printing new LUNA as necessary. The problem, as readers might have already spotted, is that there is no reason to think that LUNA should be worth anything at all. “On first principles this is insane,” Bloomberg’s Matt Levine wrote back in April. And while he speculated that sheer meme hype might keep it afloat, “insane” was the right word. On Monday, a classic death spiral got going: Terra broke its peg and started falling, the value of LUNA plummeted, and both are now all but worthless. At time of writing, TerraUSD was at just 30 cents, while LUNA had fallen 99.999 percent to less than one penny.
Crypto enthusiasts struggle to point to any practical benefit of their technology, especially one that would compensate for the downsides that we’re now seeing. Most clearly, we have internet funny money that constantly seesaws between hyperinflation and hyperdeflation, with both enormous transaction costs and gigantic negative externalities. Then there is this kind of ultra-risky financial speculation that amounts to a recreation of the pre-2008 shadow banking system except much, much worse.
As crypto skeptic Molly White points out, “My overwhelming feeling is that Web3 projects seem to be a solution in search of a problem.” It’s notable that when The New York Times’ Kevin Roose, a tech reporter who is quite sympathetic to crypto, tried to find a reasonable use case for the stuff, the best he could come up with was … a tiny company that is selling medium-range wireless internet.
Unfortunately, before circling the drain the crypto industry minted several billionaires, who are now becoming major players in politics in an attempt to prevent any of the regulation that should have happened in the first place. Sam Bankman-Fried, the Bahamas-residenced head of FTX, met last night with the Problem Solvers Caucus and promised to max out to any member who showed up. Crypto’s early adopters are now trying to dictate regulatory policy, while those who got in just afterward saw the rug pulled out from under them.
At least this mess does provide a couple of salutary lessons. First, there is practically no limit to what people can believe if it seems it will make them a lot of money fast. Second, libertarian schemes to engineer around the need for government and trust are doomed to failure, always. Crypto bros are getting a warp-speed lesson in why we can’t do without banking regulations.
