The Crypto Crash Has Arrived
Bitcoin is trading at around $11,000 (as of this writing). That’s alright if you were among those who bought it before the wild ride that propelled it almost to $20,000, like a Saturn V rocket, in December 2017.
Ethereum is cheaper, but it’s subject to the same forces pulling Bitcoin back to the surface. It has lost almost 30% of its value in a matter of days. Ripple has lost almost two thirds, going from a peak of $2,720 on January 8 to less than $1,050 on January 17. This might be a good time to make sure your joints and bones are working well, because we’re in for a hard landing: the signs say that a crypto crash in 2018—more than a crypto correction—has arrived.
The total market cap for all cryptocurrencies has dropped from about $700.0 billion to about $450.0 billion in little over a week. (Source: “Cryptocurrency Market Capitalizations,” CoinMarketCap, last accessed January 17, 2018.)
Some suggest that the crypto crash is in full swing. Others remain convinced by the reasonable analysis that the crash is coming off the steep peaks that Bitcoin and other cryptocurrencies achieved last December. They remain hopeful that the losses will be contained at the November highs.
The problem is, unlike a stock and its derivatives, or a convertible currency like the euro or the dollar, or—of course, gold—there’s nothing to back up the value of cryptocurrencies. There’s nothing that can help investors predict their course.
Bluntly, there was nothing about Bitcoin, Ethereum, or—insert name of one of 1,700+ cryptocurrencies—that inspired confidence. Top investors whose who have built multi-billion-dollar fortunes, like Warren Buffett, have expressed comments on the edge of contempt for the “crypto-mania.”
Jeremy Grantham, who warned investors of the inherent dangers in the markets ahead of the 2000 and 2008 market crashes, fears that Bitcoin will burst within two years. And, none other than Ethereum’s co-founder, Charles Hoskinson, has sounded the alarm over this 21st century manifestation of tulip-mania.
The correction that these gurus have expected has begun, except that, so far, it looks more like a Bitcoin crash than a simple correction. The other cryptocurrencies are riding the same wave, thus an Ethereum crash is entirely probable—and certainly possible.
Reasons for the Crypto Crash
Those seeking an explanation for the cryptocurrency crash would find better answers in the realm of psychology and faith than in finance or economics.
There’s little that’s rational about the huge gains that Bitcoin (and other “currencies” like it) have posted over the past few months. But there’s much that’s human about them.
The roots of the cryptocurrency phenomenon are ancient. Indeed, they can be seen in stories about Saint Anthony of Padua, also known as Saint Anthony of Lisbon, who lived from 1195 to 1231.
Saint Anthony earned a reputation among believers as one of the most diligent saints in fulfilling requests and performing miracles.
His most famous miracle involved a letter that a woman in Spain wrote to her merchant husband in Peru after a long absence in 1729. To ensure the letter’s arrival, the woman placed the letter in the hand of a large statue of Saint Anthony in the Church of St. Francis in Oviedo. Her intuition paid off; the next day (from the same hand of the statue), she received a letter in return, along with gold coins. Saint Anthony had performed a miracle! (Source: “S.A.G. St Anthony Guide -Miraculous letter deliveries,” Miracles of the Saints, last accessed January 17, 2018.)
Since that famous episode, many people who believe and need help have written the acronym “S.A.G.” on the envelopes of what are popularly known as chain letters.
Technology has enabled the phenomenon, as many of you who own an e-mail account have certainly noticed. The letters from widows of Nigerian princes promising great fortunes in exchange for small favors have become a classic. But there are more insidious variants or derivatives, just as in finance. Add dollar signs and promises to chain letters, and a get-rich quick scheme is born.
The writer of a S.A.G.-type letter asks those who receive it to send money to those who originated it. Does that paint a familiar picture? It should. It’s a pyramid scheme. An Italian immigrant, one Charles Ponzi, perfected it. Yes, he’s the person who invented the economic model of promising massive returns on an asset or product, provided that the new investors recruit newer investors, and so on.
In such a system, only those at the start of the scheme become rich—effortlessly. One Bernard Madoff has much to say about it.
Why Did the Crypto Crash Happen?
The principal characteristic of a Ponzi scheme is that the “investors” make money only from the sums that the new recruits invest. There are no actual industrial or financial activities involved.
This is not to suggest that Bitcoin or other cryptocurrencies are Ponzi or pyramid schemes. They do, however, share many things in common, foremost of which is the fact that those at the tip of the pyramid will end up with money in the case of a crash. In some ways, it’s already happening.
Algebris Investments CEO Davide Serra said this of Bitcoin in a tweet:
Bitcoin is money laundering tool for criminals/tax cheaters that has been transformed in the biggest Ponzi Scheme of all time with a value of $160bn (3x Madoff) an I am amazed not a single regulator takes action. Just unbelievable
— Davide Serra (@davidealgebris) November 29, 2017
Bitcoin does not involve active recruitment of unsuspecting victims. It doesn’t even promise gains or support its house of cards with regular funds. Still, Bitcoin may well be the Ponzi scheme’s first cousin, the speculative bubble. It sells hope, and its value is based solely on perception.
That means it is subject, however, to the same psychological mechanisms that allow the Bernie Madoffs of this world to find many suckers before they are caught.
The fact that the identity of one Satoshi Nakamoto remains as cryptic as the Bitcoin currency he founded doesn’t inspire much confidence either. After all, a Ponzi scheme works best (i.e. the perpetrator doesn’t get caught) if the initiator disappears just before someone catches on. A bubble is similar.
What term would anyone with any market experience use to describe a phenomenon in which a currency moves from $1,000 to $19,000 without any solid reason, other than speculation?
Add to that the fact that the currency remains unregulated, which allows it to serve as a convenient money-laundering tool. That said, the converts may want to believe that Bitcoin, Ethereum, and others are going to stabilize at the November 2017 highs after the current crypto crash. But, it’s a characteristic of the best bubbles for them to implode at a far more intense rate than they inflated. The pattern of cryptocurrencies meets that criterion so far in 2018.
Ask Yourself a Question Before Diving into Bitcoin
As a sign of good faith that perhaps there’s something to this crypto trend, ask yourself a simple question before you put your real money into it: “Do I understand how an algorithm running on thousands of computers in thousands of places—being processed by nobody I’ve ever heard of—can generate value?”
When you invest in gold, you know what that is. When you invest in a currency like the dollar or the euro, you understand the mechanisms that regulate its value. When you invest in a stock on Wall Street, you understand the service or product that the company provides or makes. That’s why, even if you’ve decided to take a plunge into crypto, it’s best to maintain some healthy skepticism.
The only thing most people understand about Bitcoin, for example, is that they expect it to increase in price.
They don’t really know or care to know what it is and how it works. This illiteracy is the primary fuel that inflates bubbles and encourages Ponzi scheme trolls. Call me a cynic, but I still believe in that old principle of physics that nothing is created from nothing. Perhaps Saint Anthony of Padua can persuade me otherwise?