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Is Crypto Dead?

The year 2022 hasn’t been kind to cryptocurrency investors. Indeed, it’s been a litany of disasters.

Bitcoin, the cryptocurrency with the largest market cap, is down 75% from its all-time high in 2021 and 63% from the beginning of the year. Indeed, the value of the global cryptocurrency market has fallen from nearly $3 trillion to around $879 billion.

What’s more, several big cryptocurrency projects have disintegrated. In May, TerraUSD (UST), an “algorithmic stablecoin” tied to the value of the US dollar, collapsed. The value of a Terra, assuming you can sell it at all, is now around two cents – not one dollar.

In June, Three Arrows Capital, one of the world’s largest cryptocurrency hedge funds, defaulted on a $660 million loan and was subsequently ordered to liquidate by a court in the British Virgin Islands.

Also in June, Celsius Network, which once offered interest rates up to 14% on cryptocurrency deposits, paused all transfers and withdrawals. In July, the company filed for bankruptcy.

Cryptocurrency giant FTX, at the time the world’s fourth-largest cryptocurrency exchange, lent money to several cryptocurrency companies experiencing a liquidity crisis during this period, among them cryptocurrency lender, BlockFi. It also agreed to acquire Voyager Digital, the company that lent $660 million to Three Arrows.

But in November, FTX itself disintegrated and filed for bankruptcy. Those holding accounts with FTX had been promised that the company wouldn’t lend out their assets. That turned out to be a lie. Much of the money was apparently lent to FTX’s sister company, Alameda. When the smoke clears, FTX accountholders could lose as much as $2 billion.

Also in November, Genesis Global Capital, the so-called “Goldman-Sachs of crypto,” suspended withdrawals due to “unprecedented market turmoil.” As well, just two weeks ago, BlockFi filed for bankruptcy.

And it’s not over yet.

The next domino to fall could be Tether; like TerraUSD, another stablecoin linked 1:1 to the US dollar. The difference is that unlike TerraUSD, the $65.6 billion worth cryptocurrency tokens issued by Tether are supposedly backed by real assets. We say “supposedly,” because there have long been questions about the company’s opaque balance sheet and questionable accounting practices.

If Tether collapses, we could see a mass liquidation type event as everyone gives up on cryptocurrencies at once.

Or not. It’s possible that Tether is as good as its word and that its 1: 1 peg against the dollar would be maintained, even if investors cash out of Tether all at once.

At the end of the day, an asset – including a cryptocurrency – is worth only as much as someone is willing to pay for it. As we pointed out last week:

We must confess to not having any idea what the “real” value of bitcoin is. Indeed, we’ve read estimates ranging from zero to more than $500,000 per BTC.

Who Will Rescue Crypto?

As the carnage continues, it’s become clear that when one cryptocurrency player collapses, others follow. This is because as Bloomberg columnist Edward Harrison recently observed:

We now know FTX couldn’t rescue BlockFi because they were in trouble themselves. FTX had loaned out customer funds in non-arm’s length transactions to the affiliated Alameda Research, which lost that money, bankrupting itself and FTX in the process. So, now BlockFi has also applied for bankruptcy protection. The cascade of defaults and bankruptcies will continue until the threat of counterparty risk is negligible.

Harrison goes on to compare the debacle the cryptocurrency market now finds itself in to that of the US economy in 2008 when the investment bank Lehman Brothers collapsed. The Federal Reserve stepped in to arrange a swap of some of Lehman’s distressed assets in exchange for loans and other assistance which ensured an orderly liquidation. That helped slow the contagion to other financial institutions.

Without a similar intervention in the cryptocurrency markets, as Harrison puts it, “there is nothing stopping many of these assets from going to zero.” And we think the likelihood of the Fed or other deep pockets stepping in to stop the bleeding at close to zero as well.

But the meltdown is facilitating the transition to very different type of cryptocurrencies – those issued and controlled by central banks; so-called “central bank digital currencies” (CBDCs). Indeed, around  90% of global central banks are already in the process of adopting CBDCs. Here in the United States, the Federal Reserve Bank of New York launched a CBDC pilot program with major banks last month.

Once introduced, CBDCs will gain market share since central banks will make them convenient to use. And consumers will flock to them, especially now that it’s become increasingly clear that the cryptocurrency marketplace as it currently exists is effectively a Ponzi Scheme.

The advantage of CBDCs from the standpoint of central banks and governments is that they can be inflated at will and also micro-managed. Central banks will directly control the CBDC supply, making it possible to inject fiat money into the economy with the click of a mouse.

CBDCs can also function literally as programmable money under whatever provisions a central bank wishes to employ. China’s CBDC, the digital renminbi, can be programmed to be activated or expire on a certain date, be valid only for designated purposes or purchases, and made available only to citizens who have social credit scores above a preset minimum.

During economic downturns, CBDCs could also be programmed to have negative interest rates if you don’t spend them fast enough. They could also be restricted so that there’s no way to exchange them for cash (assuming it still exists), other currencies, or more reliable stores of value such as precious metals. Indeed, a central bank could impose capital controls at the click of a mouse.

This nightmare scenario, while admittedly alarming, is nowhere close to becoming a reality in the United States. And when the Fed introduces its own CBDC, it might choose not to include the social control measures that feature so prominently in the digital renminbi.

Indeed, to ensure widespread acceptance, they probably wouldn’t be included – at least not initially. But they could be added on as a “temporary emergency measure” during the next financial crisis.

All this makes us more enthusiastic about keeping a store of physical gold, silver and cash close at hand. Not to mention a secure stash of assets offshore.

We can’t guarantee those assets would be completely safe in the next financial crisis. But they’ll likely be far better protected than say, an account stuffed full of programmable digital dollars that Uncle Sam decides can be spent only on “essential goods” or that’s been frozen altogether.

Plan B, anyone? 

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