Crypto’s turmoil teaches hard, but not new, lessons

Fortune favors the brave, according to a crypto exchange, crypto.com, in a commercial hosted by basketball star LeBron James. It was part of a crypto advertising blitz during the Super Bowl in February, as the industry splashed out on celebrity-backed segments that would reach more than 200 million viewers. Crypto has really entered the mainstream. Four months later, heavy losses too, as the war in Ukraine, creeping inflation and general market fears have tamed the animal spirits.

This week alone, a major crypto exchange, Binance, briefly halted Bitcoin withdrawals, and Celsius, a lending platform, blocked withdrawals. Meanwhile, crypto.com, perhaps not feeling so bold, announced job cuts, as did a listed rival, Coinbase. Bitcoin's value has temporarily fallen below its "realized price" of $20,000 from its November high of $68,000 - meaning the average buyer has lost money.

For many, it was a hard lesson to learn. For some, the lesson was life-changing. In South Korea, extra police have been deployed to patrol Seoul's Mapo Bridge, a known suicide spot, since the collapse of a so-called algorithmic stablecoin, terraUSD, last month. But it's not a new lesson: fear and greed are powerful motivators, and even assets with little intrinsic value will rise in price if there is enough demand, be it tulip bulbs or cryptocurrencies. Or, as Bill Gates put it this week, cryptocurrencies are “100 percent based on the greater fool theory.”

For others, including large macro investors, who have bought into crypto, the fact that it is a speculative, highly volatile bet is the point. But as risk appetite has waned this year, ditching crypto is an easy move. This has, of course, worsened crypto's decline and will be felt most acutely by inexperienced investors.

The recent turmoil has increased calls for these armchair investors to be protected. Of course, those who sell them false promises should be ostracized, as they would in any industry. Tokens that are securities but do not comply with existing laws are rightly facing the wrath of market watchdogs. But many taxpayers would balk at the idea that they should bail out others who bet on risky assets that came with consistent warnings. Unfortunately, one lesson for regulators is that their health warnings around crypto cannot match the recommendations of Hollywood actors or Premier League football clubs.

The risk of widespread losses – and the crypto turmoil spilling over into the real world – is enough that some guardrails are needed. There has been some progress in developing frameworks in the US, UK and EU, despite internal turf wars and concerns that complicating the current simplicity of a largely unregulated, unprotected product could have its own unintended consequences. But how can a phenomenon that is everywhere and yet nowhere be properly regulated? Crypto’s decentralized structure is designed to be beyond the reach of national governments – a red flag or a libertarian goal, depending on your point of view.

A start would be to focus on where crypto and fiat currencies meet, namely stablecoins, which claim to be backed by real-world assets so traders can safely park their money between bets on more volatile coins. This promise needs to be tested and stablecoins should be subject to capital and liquidity requirements. But unless the world acts in lockstep, little will be achieved to control an online industry that operates across borders. Until then, investors should remember another adage that hasn't pushed the crypto industry forward: If it looks too good to be true, it probably is.