Fintech

All of your crypto crash questions answered (except 'Wen Lambo?')

A chaotic market deserves chaotic explanations.

Stocks

We're answering all your questions about the crypto crash.

Photo: Chris Liverani/Unsplash

People started talking about another crypto winter in January, when falling prices had wiped out $1 trillion in value from November’s peak. Prices rallied back in March, restoring some of the losses. Then crypto fell hard again, with bitcoin down more than 60% from its all-time high and other cryptocurrencies harder hit. The market’s message was clear: Crypto winter was no longer coming. It’s here.

If you’ve got questions about the crypto crash, the Protocol Fintech team has answers.

What triggered the crash?

The stock market is facing a general downturn, particularly in tech stocks. That was already having knock-on effects on the crypto markets. Central banks are hiking benchmark rates and selling assets they acquired over the past two years, leading other investors to sell riskier assets like crypto.

Amid that macroeconomic environment, UST, an algorithmic stablecoin, lost its peg to the dollar in early May. UST was tied to another cryptocurrency, luna: They’re both backed by Terraform Labs and operate on the Terra blockchain. In an attempt to stabilize the currencies, the nonprofit Luna Foundation Guard lent out $1.5 billion in bitcoin and UST.

It didn’t work, but the UST rescue attempt added to the selling pressure on bitcoin, which has hovered around $30,000, well below its November peak above $67,000 and 30% below its price in late April.

What’s the outlook for crypto investing?

Tech overall is in an unwinding now, and crypto is having its own version of that, said David Pakman, managing partner at CoinFund. “I think we have many more quarters of the unwinding to happen, irrespective of if the Fed gets dovish,” he said. Since the depth of the downturn is still unknown, CoinFund has for the past six months advised its startups to have enough cash to last at least two and a half years, he said.

At many startup board meetings, the conversation has changed dramatically. “Already the topic has changed at board meetings from, ‘Maybe we should slow our hiring,’ to, ‘Should we have reduction-in-force layoffs?’” Pakman said.

There could be much more carnage to come, Pakman said, but he’s optimistic that when the dust settles, crypto will have higher potential for growth than other sectors, based on new uses for crypto that might emerge even in dark economic times.

There’s some evidence to support Pakman’s optimism: Despite the collapse in bitcoin’s price, the bitcoin network’s hash rate, a measure of the computing power deployed to verify and record transactions, has hit new highs.

What exactly happened with UST and luna?

UST is an algorithmic stablecoin, meaning its peg to the dollar is meant to be supported by automated trading programs that mint or burn UST and luna to maintain its price. As UST lost its peg, those programs attempted to mint more luna. But the Terra blockchain wasn’t powerful enough to support the volume of transactions needed to maintain the peg — a fact that wasn’t lost on traders, who front-ran the process and drove luna down further.

The Terra blockchain shut down and restarted repeatedly in an attempt to cope with the situation, but ultimately couldn’t salvage the situation. Terraform Labs co-founder Do Kwon proposed restarting the project by handing over governance to UST and luna holders.

The crash underlined the risks of the equivalent of bank runs in crypto, especially on stablecoin. Regulators have been warning for a while that they could cause serious instability to the financial system, and Treasury Secretary Janet Yellen mentioned the UST situation in a May Senate hearing.

As of May 16, UST was trading at about $0.11 and luna was all but worthless, according to CoinMarketCap.

Binance, which had invested in Terraform Labs and received luna tokens, saw a $1.6 billion paper loss on that investment, CEO Changpeng Zhao said on Twitter.

Are other stablecoins at risk?

Tether, the world’s biggest stablecoin by market value, wobbled a bit recently, briefly losing its peg before recovering. USDC, the second biggest stablecoin, has retained its $1 peg. Unlike UST, both stablecoins are backed by substantial reserves, largely commercial paper and U.S. Treasuries. The tether coin’s backers have been criticized for not providing enough disclosures about its reserves. Circle, which helped create USDC, has promised to include data about its reserves and SEC filings; it has a deal to go public through a SPAC merger.

What about all those DeFi hacks I’ve heard about?

There’s one more factor weighing on the crypto sector. Things haven’t been looking great for DeFi security for a while now, with the amount of crypto stolen in the first four months of 2022, estimated at $1.57 billion by PeckShield, already surpassing the amount stolen in all of 2021. The biggest attacks in 2022 have taken aim at systemic vulnerabilities like cross-chain bridges, which has allowed for bigger heists than the social engineering attacks that typified 2021.

The crash has exacerbated the problem in at least one case. Blizz Finance, an Avalanche-based liquidity protocol, said on May 12 that its protocol was drained through an attack that involved depositing near-worthless luna, taking advantage of a price-data discrepancy. The Venus protocol was similarly attacked.

Are regulators about to clamp down on crypto?

The rapid growth of crypto has led to heightened concerns from regulators led by the SEC, CFTC and Treasury Department, as well as from prominent political figures including Sens. Elizabeth Warren, Pat Toomey and Cynthia Lummis. The Biden administration issued an executive order on crypto in March which noted that it’s important for the U.S. to lead in blockchain and crypto technology while stressing the need to protect consumers, investors and businesses.

Major agencies like the SEC have begun imposing new rules for crypto companies and have even threatened legal action against companies. However, the drafting of new regulations and even laws related to crypto is expected to take years.

The U.K., EU and other jurisdictions around the world have also planned tighter regulation of the crypto sector.

Is the crypto market going to zero?

Even in the last notable crypto winter in 2018, bitcoin dropped to $5,000, not $0. Cryptocurrencies have seen several market cycles in the 13 years since the first bitcoin was mined in 2009. While crypto is expected to face more scrutiny from governments, even some of crypto’s harshest critics have offered praise for the blockchain technology that undergirds it. In a 2021 speech, SEC Chair Gary Gensler called cryptocurrency a “catalyst for change” in the financial markets. And most regulators and legislators have cautiously noted the need to preserve room for innovation while reining in crypto’s speculative excesses.

OK, we’ll bite. What was ‘Wen Lambo’ about?

In 2013, a 4chan habitué bought a 2014 Lamborghini Gallardo for approximately 217 bitcoin. Lamborghinis, or Lambos, subsequently became a status symbol for newly crowned crypto millionaires. The irony: Even with the recent crash, that Lambo cost the buyer $6 million at current prices.

Should I buy the dip?

If it’s guacamole, sure. Guacamole is delicious.

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